More About Profit Targets

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Last week, we took a look at the several ways that traders could set their stop losses. The lesson would not be complete if we do not take a look at how traders could take profits. I mean setting stops is only half the job. So if you can set stops and then set the right profit targets, you will be on your way to drastically improving your trade results. It really makes no sense just to have a plan to prevent your trades from losing too much money without thinking of how you can actually make and capture the money from the market. I mean that is why we are in forex; to capture the money and use it to pay for some real good things to make life easier and sweeter.

So how can traders capture and keep profits in the market? There are several techniques and we are going to look at them one after the other in simple and uncomplicated language.

 

Targeting: The Key

What makes snipers so deadly on the battlefield is their ability to use sights to pick out their targets, sometimes up to 5 km away. This what you need to do as a forex trader when capturing targets: use your trading knowledge and the application of the tenets of this article to pick profits while you are still far off. Here are several ways to do it:

Let us explain these one after the other.

 

1. FIBONACCI EXPANSION

We have an article on this which you can refer to, but this deserves special mention because it is a method that you will find very useful if you trade with the Fibonacci retracement tool. Fibonacci extensions can be traced using the Fibonacci expansion tool. Even though there are other software available for tracing the Fibonacci retracement and extension levels, I prefer to use the manual method for the best possible accuracy.

The procedure is as this. Get a daily chart and setup a retracement entry trade using the Fibonacci retracement tool and the Stochastics oscillator. When this trade is active, you can now use the Fibonacci expansion tool to trace out the trade exit areas. The profit target areas with the Fibonacci expansion tool on the daily chart are the extension levels of 61.8%, 100% and sometimes the 161.8% levels.

TGT_Fibo

In this chart, we can see the Fibonacci retracement (FR) used to pick the long trade retracement entry at the 50% Fibo retracement line, marked in brown circle. At this point, we see the Stochastics oscillator in an oversold condition. From here on, our focus shifts to picking the most suitable portions for the trade. We then see the 1st Fibonacci extension area at 61.8% FE is clearly the first port of call for advancing prices and should therefore be used as the first profit target. Even though the price action sometimes continues beyond this point to the FE2 area at 100%, it is MUCH SAFER TO EXIT AT THE 61.8% FE LEVEL.

To summarize this, two-step process,

  1. Start by picking out a daily chart and use the Fibonacci retracement tool and Stochastics to pick out trading signals. Usually, when the Stochastics is overbought at the same time that price is at a Fibo retracement line, this marks a retracement entry level.
  2. Use the Fibonacci expansion tool to draw the Fibo extension ratios.
  3. Use the 61.8% Fibo Extension level as the profit target area.
  4. This strategy can work both ways: to the upside and to the downside.

 

2. CHART PATTERN TARGET PROJECTION

This is pretty simple and yet many traders just find a way not to get it right. Chart patterns refer to patterns we have discussed on this blog several times: triangles, rounding tops and bottoms, head and shoulders, wedges, etc. These chart patterns will always end in breakouts (except for few cases where the pattern breaks down). The question is: how far will price go following the breakout?

The safest play is to measure the height of the pattern, and extrapolate the pip distance that corresponds to the height to the breakout point and into the future. We show an example of this below:

TGT_pattern

The chart above which shows one of the rare triangle patterns in the market (the expanding triangle) says it all. We can even see that the price halted at the exact same extrapolated distance of 160 pips. The maximum height of the pattern was taken and extrapolated to give the projected profit target for the trade.
In a nutshell, the profit target in this example is attained by:

  • Measuring the maximum height of the expanding triangle pattern.
  • Projecting the same distance of the maximum height obtained above, to the break-out point and from there into the future.

The expanding triangle also has a bearish version in which the price action breaks out from the lower trend line. You just need to repeat the process in a downward direction to obtain the profit pattern there. Alright, enough of this and let’s move to the next method.

 

3. DONCHIAN CHANNEL PROJECTION

A channel is an area in price action where the highs and lows can each be separately connected by two lines which are parallel to each other. Channels can be ascending (diagonally oriented upwards), descending (diagonally oriented downwards) or horizontally oriented.
Channels are formed by the trend of the asset. So a channel which is ascending should only be used for long trades while channels which are descending should only be used for short trades. As such, the upper trend line is the target for a ascending channel, and a lower trend line is the profit target for the descending channel. All trades will therefore commence at the opposing trend line and terminate as indicated.

TGT_channel

The chart above is the chart for an ascending channel. The same principles can be used for the descending and horizontal channels. The steps to locating your profit target are very simple. Price is not expected to break of the channel, but if it does so in the direction of the trend, you can follow the trade all the way up.

  1. Apply the price channel tool on the Forex4you MT4 platform on an area which holds promise of forming a channel. The trend line on the area where the trade is to commence from should touch at least two reference lows (for ascending channel as shown above) or highs (for descending channel). For a horizontal channel, it could be either way. Stretch the channel tool into the future.
  2. Drag the other parallel line to touch the most recent high in an ascending channel (as shown above) or recent low (descending channel).
  3. Once price takes off and hits the other trend line, exit the market. You will notice that as the market activity continues over time, you will need to set new targets for your trades. Indeed, channels usually present numerous entry and exit opportunities.
  4. Sometimes, the target point may not be reached (see exit 2). In this situation, apply a trailing stop to protect the trade from being taken out by retreating price action. If you are fortunate, price may resume in the required direction and produce more profits.

 

4. TRAILING STOP-LOSS

There will be times when a trailing stop may be your best bet. After setting all your profit targets and all, you may find yourself in a situation where your network goes dead on you, or some untoward event happens: maybe your child may have spilt hot water on himself and you need to quickly dash off to attend to such an emergency.

This is where the trailing stop-loss comes to the rescue. A trailing stop is built to follow behind the market in a profitable position. It will therefore lock in your profits and not allow retracing price action to take out your position, especially when you find yourself suddenly handicapped to do anything about it. I had to learn this the hard way. I was trading in a remote location with crappy internet, and picked a potential 95 pip move. Then my network went dead. When I was able to get to another location where there was internet connectivity 2 hours later, I found out that the move had gone 93 pips in profit territory, 2 pips away from my initial target, and then retraced all the way back into loss territory. A potentially sumptuous 95 pip trade ended up being a 35 pip loss!

The key to using the trailing stop-loss successfully is not setting it too tightly as to choke the trade, and not setting it too far away as to leave a lot of pips on the table. This was adequately dealt with in our article on How to Set Trailing Stops.

 

5. PARABOLIC SAR

The Parabolic Stop-and-Reverse (SAR) is an indicator which typifies a multi-dimensional indicator. This indicator may have its drawbacks, and personally, except for the 2 entry signals that I have demonstrated on this site with this indicator, it is not really one of my favourites. However, rather than the indicator being maligned for its propensity to keep producing trade signals which are too early and lead to fakeouts, it can be used in another way…a very useful way too. It can be used to as a trade exit indicator in conjunction with the trailing stop.
What this indicator does is that it shows up as dots below each price bar in an uptrend and above each candlestick in a downtrend. As the market moves with time, the Parabolic SAR moves nearer to the market price.

If you are already in an active trade (with any entry method at all), you can apply the Parabolic SAR indicator to the chart, and use the positioning of the dots as the trailing stop for the trade. You will notice that as the trade progresses in the trader’s direction, the Parabolic SAR indicator will actually start to move towards the candlestick until it gets really close to it. The moment the dots of the indicator change position to go to the other side, the trailing stop will hold steady, and that is where it will remain if prices retreat further, until the trade is either closed out this way, or continues in its advance.

Para_TS

In this trade example above, we can see that the currency pair was in a period of downtrend for quite a long time, with the parabolic SAR located above the candles and confirming the bearish trend. A trailing stop is applied, and will be maintained at the level of the dot of the parabolic SAR. At some point, the Parabolic SAR indicator dots crossed to the other side to lie below the candles, indicating the “stop and reverse” nature of the indicator. This is where a discerning trader would take profits from this trade, as the candlestick which forms when the indicator has crossed to the other side will reverse against the trend to trigger the trailing stop.

We can therefore clearly see that the Parabolic SAR indicator can be used as a profit target indicator, when it acts like a trailing stop.

 

6. REVERSAL/NEW TRADING SIGNAL

This is almost a no-brainer. If a new trading signal appears on the charts, directing traders that something else apart from what they are following is starting to occur in the market, this may be a sign for traders to get off the train of an existing trade and jump onto a new one. But then this behoves traders to be able to monitor the charts to see when a new signal comes up. Usually if a trader has a trailing stop going, then the reaction of the price to a new signal will not jeopardize the position. Otherwise, the trader just has to be alive to the formation of new signals on the chart. These new signals can be in the form of the following:

  • Candlestick patterns such as pin bars, engulfing candles or doji patterns. See our article on candlestick patterns to see the candlestick patterns that form new signals.
  • Price action reacting to a fundamental influence such as a news trade.
  • A new moving average cross which occurs in the direction that is opposite that of the ongoing trade.

If a new/reversal signal occurs, it just makes plain sense to quit the old trade and enter a new one. So if you are long on a currency pair, simply take your profits when a bearish signal appears. If you are short on a currency pair, take your profits when a long signal appears. In this chart below, we will show examples of how a new signal caused the price action to change direction, signaling that the trader should beat a tactical retreat with an exit. This is exactly what we mean right here:

Take this cue. If a new or reversal signal occurs on the charts, then the trader should apply the volume indicator to see whether the new signal is being confirmed by an increase in trade volume. If indeed the signal is confirmed by an increase in the volume, then there is every likelihood that other major market players have already caught the cue and are moving in the reverse direction. You probably should too at this point.

 

7. TIME-BASED PROFIT TARGET

In the article on stop losses we sent out last week, we discussed time-based stops. Just as we have time-based stops, we also have time-based profit targets. This is the use of time in determining when to exit a trade. This method has more application for intraday traders, who do not have much capital and would not like to see their capital tied up in trades for days on end when they can use such to take trades on a daily basis.

Another reason why some traders do not like to keep positions overnight is to avoid paying swaps when they are long on currencies with low interest rates. Here is an example of a time-based trade:

TGT_time

Here is a trade in which we were short on the NZDUSD. However, with the Australian GDP report to be released the next day, and considering the fact that the AUD tends to drag up the NZD with it since both economies are closely linked, a decision was made to take profits as soon as the new trading day opened: a time-based profit target play. Being short on the higher interest yielding currency, we were forced to pay a swap for the 2 days the trade was open, reducing our profits by $11.40.

Assuming we had taken such a trade with 10 lots of currency ($100 a pip), this would have increased the amount we paid as swap by a factor of 10 to $114. One hundred and fourteen dollars may not seem significant to you, but when you look a story of how a couple incurred a payday loan interest of $1,700 on a $450 payment, then you will understand that in a world where a lot of people live on less than a dollar a day, $114 can make a difference in some people’s lives.

Some traders do not want to have to keep paying such money. If you look at the chart, you will see that the NZDUSD began to rise shortly thereafter. If the trade had been left open, the trader would have had to contend with a retreating position, PLUS payment of swaps, which would have eroded the position faster. For such traders, time-based profit targets will be useful to use.

 

8. PAST SWING PIVOTS

What do we mean by swing pivots? Swing pivots are simply market turning points. You may refer to these as the swing high and swing low. The reason why we can use swing highs and lows as profit target areas for long and short trades respectively is because these turning points are effective markers of support and resistance levels, especially those at major market tops and bottoms.

Usually, if charts are condensed, it will be possible to see that these swing highs and lows have actually occurred at the same levels at some time in the past, and this is why traders will tend to respect them. If an indicator capable of deciphering when the market is overbought or oversold is added to the charts, then a measure of reliability is added to the use of these areas as profit targets. So by projecting the price action into the future to meet these areas, we get reliable profit targets.

Generally, we look for bearish targets using past swing lows and bullish ones with swing highs.

swing pivots

This example shows the price action of the EURJPY over a period of time. The zoom tool was used to reduce the magnification of the chart so that the previous swing highs and lows can be brought to focus. We can clearly see that the occurrence of the most recent swing highs and swing lows, is an exact replication of the historical swing highs and swing lows, thus creating a valid case for using the recent swing pivots as genuine support and resistance areas. For good measure, the Stochastics oscillator was added to the charts, clearly showing the swing highs to correspond to overbought areas and the swing low corresponding to oversold conditions. So a trader who has an open short trade initiated from a swing high can use the swing low as a profit target, and a trader who went long on the asset from the initial swing low can use the most recent swing high as a profit target for his trade.

This goes to clearly show that he observance of past swing pivot points is a clear-cut and robust way to locate support and resistance areas for use as profit targets.

 

CONCLUSION

In this article, we have listed out 8 ways by which you can exit your trades with a profit. As a trader, it is not practicable to use all the methods listed. Rather, it would make more sense to use one or two of these methods according to your personality, trading style and of course, ease of use and application.

So how do you decide which one to use among these methods? Consider the following metrics when making your decision:

 

A) TRADING STYLE (TREND OR RANGE)

Are you a trend trader or a range trader? Obviously range traders will benefit more from the use of swing pivots while trend traders will benefit from the use of the Parabolic SAR trailing stop method. The concept of range trading is that the market is moving within a well-defined range with a floor and a ceiling. It follows that the trading range sets limits our profit potential. Hence, using trailing stop-losses to let profits run is inconsistent with this method as limits within which the price will move are already defined.

If for instance, you prefer to trade trends and want to let profits run or pursue prices to their logical conclusion, then you would be better served using methods that employ trailing stop-losses. If you prefer to scalp for small profits within a trading range, you can use target orders.

These are not hard and fast rules, but merely a demonstration of how a trader’s individual style will determine which of the profit target methods will be better suited for the trading style.

 

B) TRADING TIME-FRAME

Your trading time horizon is also a key consideration to make when considering your method of profit targeting. For instance, day traders will benefit more from having target orders than using trailing stops. This is because the range of each trading session limits their profit potential. Facing such limits, there is little point in letting profits run with trailing stop-losses. Target orders will thus be more suitable.

If you are a swing or position trader where you can hold on to positions without time limitations, then trailing stop-losses are the preferred choice of profit targeting.

 

C) LOOK FOR CONFLUENCE OF TARGETS

For those using target limit orders, find the best price targets using the concept of confluence. This means that if you get a Fibonacci extension target, a chart pattern measured target, and a major swing pivot clustering around a price level, you smile.

In all this, it is noteworthy to remember that there is no such thing as a perfect target. Targets are not set in stone because the reversal of prices at a certain point is due to the reverse activity of traders and it is impossible for millions of traders all over the world to use one particular point as their target. Trying to look for the perfect exit is as dangerous as attempting to find the Holy Grail of the perfect entry. You therefore have to make allowances for drawdowns or for allowing the market to take some of your pips when setting your trade entries and exits. Even if you see price action continuing in the same direction after you have exited the trade, do not ever be tempted to re-enter the trade in an attempt to add some more. By this time, such moves will have very little left and you could end up at the receiving end of a nasty retracement.

Rather, look for other better opportunities. There is always opportunity in the forex market. You only have to open your eyes to see it. Finally, ensure that your profit targets will give you at least double for whatever you risked as your stop loss.

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About Author

Dankra is a forex trader who has played the markets for 7 years. He also trades binary options and spends his free time developing strategies that traders can use to beat the markets. He also codes indicators and EAs for the MT4 platform.