This week’s article is all about setting profit targets. No fluffy intro on this one. We’re cutting to the chase and tackling the what, why, and how of price targets. Also, I’m focusing on stock trading only here. That will allow us to keep our discussion simple and straightforward.
The What and Why of Targets
If you subscribe to the wisdom of planning your trade before you throw your dough in the market and get all emotional, then using targets is vital. Traders use price targets to calculate the potential upside or reward in a trade. If I buy a stock for $50 and have a target of $55, then $5 is my reward.
A target is an estimated price you think the stock could achieve in your trade’s time frame. I have two rules for picking a target.
First: It needs to be realistic given your time frame.
Second: It should be based on a rule that is repeatable and consistent.
Let’s take a brief look at each.
If you’re swing trading with an average trade duration of 3 to 8 days, then you should pick a target that the stock has historically reached within 3 to 8 days. In my experience, 1 to 3 ATRs is doable. If your target is more than 3 ATRs away, you run the risk of taking multiple swings to reach it. This isn’t automatically bad, per se, but you have to bake it into your expectations. In other words, you better be willing to sit through some chop or a pullback in the middle of the trade.
In addition to the Average True Range, using P.A.Y. range (or the typical distance between support & resistance) is a good technique for forecasting realistic targets.
Whatever your method for selecting price targets, I suggest being consistent. In other words, don’t randomly choose targets on each trade.
“I’ll sell for 1 ATR on stock A. I’ll go for the prior pivot high for stock B. And for stock C, I’ll use 1 PAY range as my target.”This is too random.
I’m not opposed to letting the overall market environment drive different targeting techniques, but be careful with being too willy-nilly. For example, when the market is more bullish (+2,+3), letting winners ride and shooting for larger targets makes sense. Alternatively, when the market is more neutral, going for quicker targets makes sense.
Why do we use targets? Because a) they allow us to calculate the potential reward, and b) they allow us to predetermine our exit point and management plan.
A target is a selected price level that you think the stock can reach over the trade’s time frame. Day traders have smaller targets than swing traders. And swing traders have smaller targets than position traders. This is because as you lengthen the hold time, a stock can realistically rise further.
For the typical swing trade setup you see us highlight in our weekly Scouting Reports, we use three methods for targeting. These move from a smaller, quicker target to a larger “stretch” goal. One ATR is a common quick target. The prior pivot high or resistance zone is a normal target. Projecting the next peak based on P.A.Y range or an upper trendline would establish a “stretch” target.
I Hit the Target, Now What?
When your stock rises to your price target, it doesn’t mean you automatically sell. You can, of course. But consider two alternative actions that will help you better maximize gains over time.
One: Tighten your stop loss. This technique makes the market take you out by reversing lower instead of you guessing that it’s topping out.
Two: Take partial profits. This sets up a potential win-win. If prices continue rising, then at least you only sold half. If prices reverse lower, then at least you took some profits.
If you need some visual examples, we provide a dozen of them every week in the Stock Report.
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