photo by Frits Ahlefeldt-Laurvig
Before you even think about taking your next trade you better first assess your risk to reward ratio to make sure the trade is worth taking.
Isn’t that what the trading books tell us we need to do?
Isn’t that what we have to do if we want to be a successful trader?
It doesn’t have to be, and in this article we’re going to breakdown some of the pros and cons of trading using profit targets.
Cons of trading with profit targets
When you enter a trade with a specific profit target in mind you are subconsciously anchoring yourself to that fixed price.
You are limiting your upside, by placing a cap on your potential profit.
You are effectively saying,
“Whoa whoa Mr. market, I don’t care that you might want to run to $103 a share today, I just want to settle for my $100 target because this trade is only designed for a 3 to 1 risk to reward.”
How nuts does that sound?
I’m a big fan of staying adaptive and reacting to new information, rather than trying to front run and predict what markets may do. Only after the market has clearly proved to me what it’s intentions are, do I take a trade.
That same thought process can be applied when thinking about profit targets.
Having a profit target implies you can predict the maximum point price will move in your favor before immediately reversing.
That’s a very hard thing to do.
By definition, the very best trades are going to run further than anyone thought possible, and by having a conservative or rigid framework, you’re setting yourself up to miss out.
Pros of trading with profit targets
In some market environments having aggressive profit targets is the only thing that will save you. Think about choppy, volatile markets that are constantly taking 2 steps forward and then 3 steps back.
If you fail to lock in gains before the market starts pulling back, you’re consistently going to get chewed up. Profit targets become essential.
Having attainable profit targets also reinforces positive feedback and builds confidence.
For a discretionary day trader who has to make lots of fast decisions throughout the day and is susceptible to going on tilt, this can be very important.
Trading with profit targets – the pros and cons
So what’s best?
Unfortunately, the general answer is, it depends.
It depends on your strategy, time-frame, goals, and honestly, much more.
But here are some things to think about.
I don’t believe you have to make a firm stance one way or the other.
In fact, we sit on both sides of the fence in our trading.
We always have profit targets when we get into a trade, but we don’t marry ourselves to that specific price point. We simply use those levels as a reference point, a guide.
Once price reaches those levels, we take a closer look at the trade.
How has it developed? Has it run there in a straight line in much shorter time than we anticipated? Or did it base and break out a series of times before getting there?
How about the market environment? How are other influencers like market internals, and market leaders holding up?
By focusing more on the specific context of the trade and market environment, we can make more informed decisions as to whether or not we should take profits on a case by case basis.
We’re also almost always using partial profit targets as opposed to full exits. This way we can take some risk off the table as the stock extends in our favor, yet still have skin in the game to participate in further gains.
Even though there’s no right or wrong, definitive answer for everyone, I hope this article has given you some ideas and use cases to think about for your own trading.
As with many things in trading, there’s no one shoe fits all.
Good luck out there.
Enjoy what you read? Share it below and be sure to tag @thetraderisk.