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Targets
The most direct way to take profit is to use a target limit order. This means that as we enter a
trade, we place a limit order at a price objective.
How do we decide on the target price?
For the technical trader, there are several reliable options.
Likewise, we can arrive at a bearish target if we project the height of the Rectangle from its
bottom.
2. Fibonacci Extension
Other than relying on geometric chart patterns, traders also use the golden ratio to project targets.
The golden ratio is closely related to the Fibonacci sequence which is a common trading premise.
Fibonacci traders uses Fibonacci Extensions for projecting targets. Using a charting software
with Fibonacci drawing tools, you can mark these potential target levels easily.
2. Project the extensions using Fibonacci ratios (0.382 and 0.618). For instance, multiply the
height of the impulse wave by 0.382. Then, extend the product from the high of the
impulse swing.
For Fibonacci Extensions, the choice of the impulse wave is critical. Select a clear and major
price thrust for best results.
This example shows a short trade. Using past swing lows, we projected several resistance levels
representing potential targets. The nearest resistance is clearly the most conservative target.
Observing past swing pivot points is a straightforward and robust way to find support/resistance.
The chart above shows a NR7 long setup. We projected a target using a price channel.
1. Draw an upwards sloping trend line with two swing lows.
2. Draw a parallel line starting from the most recent high. (Channel line)
The plan is to exit once price hits the channel line. As the market progresses, the channel line
rises. Hence, our target price is dynamic, and we need adjust the target order higher to keep up
with the channel line.
This is in stark contrast to the tactics we discussed earlier. They are static targets which do not
need adjustments.
In addition, as shown below, a channel method is the natural choice for traders operating within a
trading range, aiming for small profits.
5. Time Target
Lets look at targets from another dimension. Try time.
Having time targets refer to taking profits once a certain time period has lapsed. This method of
taking profit is relevant and perhaps critical for options traders and day traders.
Options traders (specifically buyers) need to manage their prospect of gains versus potential loss
due to time decay. Typically, the loss of time value accelerates as we approach the options
expiration date. Hence, having a time target is useful for tackling the problem of time decay.
Most day traders work within the confines of a single trading session to enjoy intra-day trading
margins and to avoid overnight risk. For them, there is a natural time target at the end of each
session.
Combine a time target with a price target for the best of both worlds.
Trailing Stop-Loss
Let your profits run.
Im sure you have heard this maxim before. If you want to adhere to this trading advice, using a
trailing stop-loss is your best bet.
A trailing stop-loss is one that follows behind the market. It has the dual function of locking in
profits and letting profits run.
However, the art of trailing stop-loss is demanding. If we trail the stop-loss order too closely, we
might suffocate the trade. If we trail it too far behind the market, we risk giving back a large part
of our profits.
For a systematic way of trailing stop-losses, use one of the following methods.
6. Parabolic SAR
J. Welles Wilder invented the ADX for tracking trends and the RSI for clarifying momentum. It
is hardly surprising that he has something up his sleeve for trailing stop-losses.
Let us introduce Wilders Parabolic Stop-and-Reverse (SAR).
From its name, we can tell that clearly, Wilder intended to use the Parabolic SAR for more than
just trailing stop-loss. He wanted to reverse the trading position after being stopped out.
However, here, we are only focusing on using it as a trailing stop-loss tool to lock in our profits.
This indicator plots a marker below each price bar in a uptrend and above each bar in a
downtrend. Its underlying concept is that time is money. Hence, as time passes, the Parabolic
SAR accelerates closer to the market price.
In this example, our entry was the bullish pin bar (doji). The blue dots plot the Parabolic SAR,
which provides a natural trailing stop-loss for our long trade.
Towards the right of the chart, you could see that the blue dots are intolerant of prolonged
sideways movement, and catches up quickly.
The exact calculation of the Parabolic SAR is a tad complicated. If you want to figure it out, the
best resource is Wilders New Concepts in Technical Trading Systems .
7. Chandelier Stop
The ideal trailing stop-loss should give enough room for minor pullbacks. Thus, a sensible
approach is to consider how volatile the instrument is.
The Chandelier Stop does that by taking the Average True Range (ATR) as a measure of
volatility. The ATR is another concept from Wilder. (Yes, we are really indebted to him.)
In a nutshell, the ATR measures volatility using the average range of each price bar and adjusts
for any gaps. If you want to see the formula, its here.
Chandelier Stop (Long Position) = Highest High of a Period (Multiple x ATR over a
Period)
Chandelier Stop (Short Position) = Lowest Low of a Period + (Multiple x ATR over a
Period)
You need to decide on two inputs: Period and Multiple. A common setting is a Period of 22 and a
Multiple of 3.
To find out where to place our stop-loss, multiply the ATR(22) by 3. Then, minus that product
from the highest high of the past 22 bars for a bullish target.
The example below shows the use of a Chandelier Stop (in blue) for a Morning Star candlestick
signal.
We marked out the Pin Bars in the chart above with our Price Action Pattern Indicator.
9. Reversal Signal
This is the commonsense exit.
Enter with a bullish signal. Take your profits with a bearish signal.
Short with a bearish signal. Cover with a bullish one.
This a nimble tactic. However, in trending markets, this method might cause premature exits and
limit our profits. This is because a trend sustains itself by giving false reversal signals to trap
traders out of the market and have them chase it.
In the example below, we entered with a bearish Engulfing candlestick. Then, a bullish Engulfing
pattern prompted us to take profits.
Extreme volume
This chart shows an example of exiting at the market following a climatic move.
1. We shorted at this bearish Reversal Bar.
2. Price fell with a parabolic curve.
3. Concurrently, volume increases.
4. The above signs of a climatic move prompted us to cover our short position.
After a climax, the market tends move listlessly (as above) or reverses sharply.
If you scalp for small profits within a trading range, use target orders.
The premise of range trading is that the market is within a trading range. It follows that the
trading range limits our profit potential. Hence, using trailing stop-losses to let profits run is
inconsistent.
Trading Time-Frame
Your trading time horizon is also a key consideration.
Day traders will benefit from having target orders. The range of each session limits their profit
potential. Facing such limits, there is little point in letting profits run with trailing stop-losses.
Target orders are suitable.
If you can hold on to positions without time constraints, then trailing stop-losses might be
preferable.