I’m joining Coach Greg for tonight’s Coaches Show to discuss the best practices for setting targets. To prime the pump and otherwise collect my thoughts, I’m exploring the topic in this week’s blog post.

My commentary will be organized into three sections addressing the following questions:

Why do we set Targets?

How do we set Targets?

I hit my target, now what?

I’ll hasten to add that if you need a more exhaustive exploration of setting targets, then check out the S.T.E.P. System video series.

Why?

I can think of two reasons why traders use targets. The first, and perhaps more important, one is because you can’t calculate the potential reward without a target. And if you don’t know what the reward is, then there’s nothing to compare the risk against to see if it’s a trade worth taking.

For example, if I purchase XYZ at $100 with a stop loss at $98, then my risk is $2. That dollar amount of risk doesn’t mean anything until I compare it against the potential reward. And I can’t do that until I identify a realistic target. If based on the chart of XYZ it has room to run from $100 to $105, then the potential upside is $5. Risking $2 to make $5 is an attractive proposition. As most of you should know, we seek asymmetric payouts where the risk is small relative to the reward.

A second reason for setting a target is it helps you plan how you’re going to manage your trade. When my stock hits a target, I take action! Sometimes I ring the register by exiting the trade, and other times I move my stop loss up.

Without a target, I wouldn’t be sure when to respond to prices moving favorably.

How?

Setting a price target is a function of chart reading. This is always true when you’re trading stock, but only sometimes true when trading options. Here are the two fundamental principles underlining target placement.

First, your target should be realistic or achievable in the expected time frame of your trade. Swing traders don’t pick targets that would take months to reach. Day traders don’t pick targets that would take weeks to reach.

Second, the target should be grounded in sound technical analysis. There are myriad methods and indicators, but the most common ones you’ll see us using are old support and resistance zones, moving averages, ATR, and P.A.Y. range.

Consider Alcoa (AA), for example. It had a bull retracement pattern and was included in this week’s Scouting Report picks. Suppose you purchased it on Monday at $14.80 when it rallied above Friday’s high. Your stop is at the pivot low of $14.18, which also marks support. The risk, then, is 62 cents.

Now, where do we put the target? In this instance, I would use the prior pivot high near $16. It’s a clear line in the sand and marks the ceiling which the Alcoa should bounce to if it’s going to continue the trend. Compared to the entry of $14.80, that leaves you with $1.20 of potential reward. By risking 62 cents to capture $1.20, your reward to risk ratio is roughly 2 to 1. Perfect!

Now, could we get more complicated and project trendlines or use PAY ranges to guess where the next swing high will come in? Sure. But you don’t need to. The reward to risk ratio was good enough at the old pivot high. Anything above that is simply icing on the cake.

Target Hit, Now What?

Here are a few things to consider when/if the stock reaches your target.

First, you cannot under any circumstances allow your trade to turn into a loser. No matter what your management technique, this outcome is unforgivable at this point. This means, at a minimum, you must put your stop at breakeven.

At most, you can sell your entire position at your target. This succeeds in capturing your anticipated reward, but it doesn’t exactly magnify your mandate of maximizing gains. What if, after taking profits on Alcoa at $16, it promptly rips to $20? Letting winners ride can do wonders in amplifying your long-term returns. I suggest adopting some type of management that allows you to do so. Perhaps you tighten your stop instead of abandoning ship altogether. Or maybe you take partial profits (this is my preferred technique).

The options market offers many choices for trade adjustment as well. These, though, are a story for another day.

Here’s the bottom line. When a stock hits your target, you must take action of some sort.

Join Greg and me tonight to see many more examples.

Legal Disclaimer

Tackle Trading LLC (“Tackle Trading”) is providing this website and any related materials, including newsletters, blog posts, videos, social media postings and any other communications (collectively, the “Materials”) on an “as-is” basis. This means that although Tackle Trading strives to make the information accurate, thorough and current, neither Tackle Trading nor the author(s) of the Materials or the moderators guarantee or warrant the Materials or accept liability for any damage, loss or expense arising from the use of the Materials, whether based in tort, contract, or otherwise. Tackle Trading is providing the Materials for educational purposes only. We are not providing legal, accounting, or financial advisory services, and this is not a solicitation or recommendation to buy or sell any stocks, options, or other financial instruments or investments. Examples that address specific assets, stocks, options or other financial instrument transactions are for illustrative purposes only and are not intended to represent specific trades or transactions that we have conducted. In fact, for the purpose of illustration, we may use examples that are different from or contrary to transactions we have conducted or positions we hold. Furthermore, this website and any information or training herein are not intended as a solicitation for any future relationship, business or otherwise, between the users and the moderators. No express or implied warranties are being made with respect to these services and products. By using the Materials, each user agrees to indemnify and hold Tackle Trading harmless from all losses, expenses and costs, including reasonable attorneys’ fees, arising out of or resulting from user’s use of the Materials. In no event shall Tackle Trading or the author(s) or moderators be liable for any direct, special, consequential or incidental damages arising out of or related to the Materials. If this limitation on damages is not enforceable in some states, the total amount of Tackle Trading’s liability to the user or others shall not exceed the amount paid by the user for such Materials.

All investing and trading in the securities market involves a high degree of risk. Any decisions to place trades in the financial markets, including trading in stocks, options or other financial instruments, is a personal decision that should only be made after conducting thorough independent research, including a personal risk and financial assessment, and prior consultation with the user’s investment, legal, tax and accounting advisers, to determine whether such trading or investment is appropriate for that user.