How Smaller Profit Targets Can Improve Your Trading

How many times have you read that in order to make money trading, you need to play for a big profit target, let your winning trades run and cut your losers short?

It’s sound advice, applicable in many places, and a great starting point for new traders.

But it’s not the only way to make money trading.

I see a lot of traders blindly following advice that if they’re not playing for a 3 to 1, 5 to 1, or 10 to 1 reward to risk ratio then they’re doing it wrong.

And that’s simply not true.

Besides not always being the most optimal trade management technique, not everyone has the discipline, patience, and genetic make-up to successfully execute on a system which inherently carries so much disappointment.

Throughout this article I’m going to make the case for throwing away this conventional wisdom and encourage you to consider the benefits of using smaller profit targets in your trading.

What kind of trader are you?

What Trader Are You - How Smaller Profit Targets Can Improve Your Trading

Everyone has to make a decision on what kind of trader they want to be.

  • Do you want to try and capture big moves, the home run swing, and maximize your reward to risk?
  • Or do you want consistency, singles and doubles, with an emphasis on maximizing your winning percentages?

It’s nearly impossible to get your way with both.

If you want trades that offer 3 to 1 or 5 to 1 or even more on your risk, then expect your winning percentages to be low.

If you’re okay making 1 for every 1 of risk, then winning percentages of 60-70%+ are reasonable.

So ask yourself, which side of the equation do you want to be on?

There’s no right or wrong answer, just understand both can be effective and each requires certain personality traits to excel.

Maximizing your reward to risk

Coins - How Smaller Profit Targets Can Improve Your Trading

I used to be a hardcore subscriber to letting my winning trades run. I would only exit on weakness and never take profits early.

I used to write about letting winners run in the past.

During strong markets, that trade management process is great.

But for the 85% of days we weren’t in a strongly trending environment, I found myself giving back way too much in open profits.

The setups I was trading, stop placement, and my trading preferences, were not in sync.

Trend following

The classic trading strategy that lends itself nicely to letting winners run is Trend Following.

Trend followers do not try and predict what markets are going to do, they simply react to price action, jump on board existing trends, and attempt to capture as large of a move as the market will give.

The goal is to continually trail a stop and capture outsized moves.

In this process there’s going to be lots of small losses, but the few trades that do end up running further than anyone would have expected (ideally) offset all of the small losing trades.

Think 80/20 rule, where 80% of the profits come from just 20% of the trades.

Why trading for big profit targets didn’t work for me

There were two primary reasons letting my winning trades run and playing for a big target wasn’t best for me.

  • I’m not willing to tolerate much movement against my position.

When I’m playing for a breakout, I want my timing to be accurate.

If the stock moves against me in any meaningful way, sufficient momentum is not there, and I look for the exit door.

By definition, letting your winning trades run and playing for a big target, requires the trader to sit through lots of uncertain price action.

How else are you going to achieve a big target? You need to give the position room to work itself higher, but that’s exactly what I don’t like doing.

Now I know you hardcore trend followers are thinking to yourself: “that’s exactly why it works, no one likes the discomfort!”

But this second point is equally as important:

  • I trade lots of quick multi-day continuation patterns and reversals, that may have strong recent momentum, but aren’t necessarily emerging from large multi-week bases or to new all-time highs.

The types of setups and patterns I trade do not model out best when trailing a stop exclusively and exiting on weakness.

Using smaller profit targets

By shifting to smaller, more modest profit targets, I not only increased my win rate but also my entire bottom line.

Here’s an example of a past trade, where taking a fast profit secured myself a small win instead of an outright loss.

Notice, if I had not taken that partial profit on the day after my entry, I would have gotten stopped out on one of the next three days that price pulled back below my entry price and ultimately below all of the recent price structure lows.

Here’s another past example trade I took in TLT, this time a reversal.

It was a counter-trend trade on the daily time-frame and the rationale for entering was as follows:

• Weekly time-frame trend was lower.
• We had just seen a 4-point rally off lows into prior supply/swing highs.
• We gapped up, failed to push higher, and then closed the day at the lows.

I entered a short position at the close of the day.

Here’s what happened the next day:

Follow through lower in my direction, a bounce off the lows, but still a profitable day one.

Here’s the next day:

A continued bounce higher putting my short trade back into the red and threatening to continue to rip my position apart.

If I was trying to trail a tight stop, this would have likely resulted in a losing trade as the risk of a further move higher would have been enough for me to exit by the close.

Luckily, that didn’t happen.

I took the entire position off that first day of follow through for a small gain.

No whipsaw, no difficult decisions.

After reviewing enough trades, many similar to the two above, I found that my entry timing was quite accurate in the short-term (one to three days), but my trade management style wasn’t taking advantage of that.

By the time day two or three came along, my stop loss may have been trailed up to break even, but ultimately the stock would pull back or chop around and result in a loss or break even.

It wasn’t until I started leveraging my strength (the timing) and began taking small to modest profit targets, where I really began maximizing profits.

 

What about your reward to risk?

Reward to Risk - How Smaller Profit Targets Can Improve Your Trading

This always seems to be the big push back I get when discussing small profit targets with other traders.

My initial response is something we already covered above, it’s simply a trade-off. Trading for small profit targets (generally) means you are sacrificing a lower reward to risk number for a higher win percentage.

My second, and more snarky remark:

Our job is to make money, not satisfy some feel-good reward-to-risk number.

I believe too many traders get too caught up in the semantics,  focusing on what they think they should be doing, rather than focusing on what actually matters, which is making money.

There is no better way to make money then by booking profits and realizing gains.

Make decisions from a position of strength

Strength - How Smaller Profit Targets Can Improve Your TradingI used to play a lot of poker, so bear with me through a quick analogy.

In poker, it almost always pays to be the aggressor.

Why?

You can win a hand in two ways, instead of just one.

  1. Showdown the best hand.
  2. Get your opponent to fold the best hand.

The key is that you’re making your opponent make the decision. And when your opponent has to make a decision, they have a chance to make the wrong one.

In the stock market, it’s not all that different.

Your opponent (the market) will constantly put you to the test and challenge you to make the wrong decision, particularly when holding a full position and playing for a big uncertain target.

During that time, your position will do a great job at selling off just enough to where you’ve placed your stop loss, dance around it in unclear terms, and cause you to doubt your trade and exit at precisely the wrong time.

When you take profits early and often, you are executing from a position of strength, on your terms, and eliminate the stress of making a decision backed against a wall.

Booking profits builds confidence

Confident - How Smaller Profit Targets Can Improve Your TradingConfidence is no joke.

If you’re a discretionary trader, retaining a healthy balance of confidence is key.

Think about the last time you had a losing streak.

5, 7, 13, or maybe even more, losing trades in a row.

It’s very difficult not to doubt everything.

Your system, your ability, the markets.

By trading a system with a high winning percentage, the equity curve sees less turbulence, which helps prevent the emotional lows from getting too low.

Small profit targets maximizes opportunity cost

I don’t want to have my capital tied up in a trade any longer than I have to.

By having small profit targets, I can rely on my market timing to be accurate and capture the bulk of a directional move without sitting through any pullbacks or consolidation.

That allows me to continuously compound gains by rotating into new ideas that are actionable and on the move.

How smaller profit targets can improve your trading

I’m clearly a fan of taking smaller profit targets often and early.

It fits my personality, time-frames, and setups, and it’s something that I can go out and confidently repeat each and every day.

I understand a lot of the times I’ll be leaving money on the table as stocks run away without me, but as long as I can get a piece of the move, and compound that process over and over again, then I’m doing my job.

Trading for small profit targets isn’t for everyone, but hopefully, after reading this article you better understand the motivations and logic for doing so.

Bonus: other tools and tips from my trading process

  • Partial profits are key for me. My profit targets may be small, but I am rarely ever exiting the entire position all at once.
  • I trade multiple time-frames. My daily swing trades are quick multi-day holds, but weekly setups can last a month or longer.
  • Staying highly adaptive is key. When we do find ourselves in a strongly trending environment, extending those small targets or taking less size off with partial profits can help maximize overall profit potential.

Enjoy what you read? Share it below and be sure to tag @thetraderisk.

Evan Medeiros

Evan is the founder of The Trade Risk, a financial media company that publishes research and analysis about the stock market and specializes in trading education. With 20+ years of coding experience and a B.S. in computer science, Evan brings a systematic discipline to investing in the stock market.

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14 Comments

  1. Brian on 3:04 pm January 28, 2017 at 3:04 pm

    Makes sense! Thanks for going deeper into the rationale and psychological perspective of your trading style.

    • Evan on 4:08 pm January 29, 2017 at 4:08 pm

      Thanks for the comment Brian, glad this was helpful.

  2. Doug on 1:38 pm January 29, 2017 at 1:38 pm

    “I believe too many traders get too caught up in the semantics, focusing on what they think they should be doing, rather than focusing on what actually matters, which is making money.” Couldn’t agree more. I’ve started taking profits earlier and more often and it seems over time the gains should compound nicely. The consistency and style suits me. Great article.

    • Evan on 4:09 pm January 29, 2017 at 4:09 pm

      Great to hear, thanks Doug!

  3. Jake on 8:04 am October 26, 2017 at 8:04 am

    Evan, I couldn’t agree more with you on this.

    During my time learning how to trade, I have read countless articles from multiple sources, that you are destined to fail as a trader if you don’t maintain a minimum 1:1 reward to risk ratio with a greater than 50% win rate. Increase both metrics for greater returns. Accompanying tables and charts illustrate the equity curves of varying ratios of both metrics. Yeah, it looks great on paper, and a simple equation to follow. In reality, we all know it’s not as straightforward as that. It makes me wonder whether the authors of this advice are real traders actually turning a profit! Because from my experience, it seems to be a fallacy. I believe the market is too dynamic for such rigid thinking. It doesn’t care about your arbitrary price targets.

    It was only when I began experimenting with ‘poor’ reward to risk ratios from looser stops based on price structure that I began to make consistent profits. My win rate immediately shot up, as did my confidence, just like you mentioned. As you say, your equity curve is much smoother due to the high win rate. It is the win rate which also dictates the probability of winning and losing streaks: the higher your win rate, the lower your frequency of losing streaks, at shorter durations too. No one seems to talk about this powerful truth though.

    It’s refreshing to read an article from an actual trader arguing so well in favour of what many argue against. I really enjoyed reading it, as well as other articles you’ve written. Thanks for posting, albeit belated (I first visited your site just a few days ago).

    Jake

    (Across the pond in the UK)

  4. Evan on 5:09 pm October 26, 2017 at 5:09 pm

    Jake, thanks so much for sharing, I really enjoyed your story. It sounds like we’re on similar wavelengths in terms of trade management and staying flexible.

    I especially like:

    “I believe the market is too dynamic for such rigid thinking. It doesn’t care about your arbitrary price targets. ”

    Keep up the good work, and thanks again for the comment!

  5. Ray Dossat on 2:41 pm January 6, 2018 at 2:41 pm

    Evan,

    Isn’t this hard to do with a small account of say $10,000?

    If you have 5 trades, that’s $2000 allocated per trade? Can’t get many shares and commission eats you up?

    Thanks for any thoughts.

    Ray Dossat

    • Evan on 3:43 pm January 6, 2018 at 3:43 pm

      Hi Ray,

      Yes you are spot on. I’ve got an article I’m trying to carve out some time to write on exactly this topic of account size versus commission costs and trading activity.

      I touch upon it in How to Get Started Swing Trading: https://www.thetraderisk.com/how-to-get-started-swing-trading-stocks/

      Small accounts, actively trading with high commissions does not work. The commission drag is just too large to overcome.

      My recommendation for most people starting out with < $10,000 is Robinhood because of the zero commission cost. Hell, I could make a good argument for everyone with under 30K should be there, but that's another post. Everyone's account size and trading activity is a bit different, but pulling out a spreadsheet to calculate exactly how much you pay in fees is a worthwhile exercise to decide if you need to either A) change brokers or B) change strategies. You can be the best day trader in the world, but if you only have 25K dollars paying $6.95 per trade and making 20 round trips per day, you won't make a dime.

  6. Patricia Novoa on 10:43 pm May 11, 2018 at 10:43 pm

    Thank you for this post! I am a beginner who is still figuring out what type of trader I want to be and I can become based on my personality and your article really resonated with me. I just subscribed to your newsletter. Thanks again.

    • Evan on 12:32 am May 12, 2018 at 12:32 am

      Hi Patricia,

      Thanks for the nice comment, I’m glad to hear it. Good luck with everything, reach out if I can ever be of some help.

  7. Jeffrey Giles on 6:24 pm May 27, 2019 at 6:24 pm

    Being a new trader, this really seemed to make a lot of sense to me. I believe that for me, at least in the early part of my current learning curve, taking smaller but more frequent profits feels most comfortable. Once I have had several to many months more of experience, knowledge and growth and as my confidence builds, I would feel OK to occasionally go for the bigger profit from time to time if it looked like it was possible and could work out that way with a particular trade. However, taking the more frequent smaller profits is still in the green and something to build upon. Thanks for the article on this.

    • Evan on 9:53 pm May 27, 2019 at 9:53 pm

      Glad you enjoyed the article Jeffrey and thanks for the comment. You’re right, building up experience and rules to help determine when there is ‘more’ in a trade is a great next step. keep up the good work.

  8. Florian on 5:33 am November 23, 2019 at 5:33 am

    Hi Evan,

    Thank you for sticking a link to this article into your weekly mail sending. I came recently much to the same conclusions, but was not yet able to really formulate it as a strategy. When reading your article it all fell into place. What I saw was that on many trades where I got whipsawed out of my position I could have still been in the green, if I had sold after a small gain of a few percent. Trader’s psychology plays into this and some may feel FOMO when they consider selling with a small profit.

    Completely agree with your points about capital being tied up too long and with the positive psychological effect of an increasing winning rate. Especially true for beginners and traders with smaller accounts. I would expect with the race for zero commissions, the concern of losing too much to fees will also go away.

    Thank you and keep up the good work!

    • Evan Medeiros on 12:16 pm November 23, 2019 at 12:16 pm

      Thanks Florian, glad this article helped! Have a good weekend.

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