How Trend Traders Find Profit Targets on Their Trade
When traders have decided to take the trend following approach, they come to a key question that needs to be answered. Should they hold onto their trade in the trend until the trend ends or should they seek a higher-probability yet lower payout profit target? While trend traders who have been made famous have taken the former approach, the latter approach of clear cut profit targets is easier to turn into a repeatable system, which appeals to many traders.
Methodologies of Profit Targets for Trend Traders
There is a multitude of tools and indicators that trend traders have used to exit trades at a profit, however, these are a few of the more popular ways to find likely exit points.
The equal waves approach is as straightforward as it gets. Once you've identified a correction or trend entry point, you only need to measure the prior trend length. For example's sake, let's say the prior trend is 500 pips long. You can add in an uptrend or subtract in a downtrend the prior trend's length and make that your profit target. This works on any degree of a trend but the larger the profit target, the more volatility you can expect and the longer you can expect your profit target to hit.
The Fibonacci Extension builds off the equal wave approach but is more customizable. The Fibonacci extension builds off the Fibonacci sequences and looks for multiples off the prior trend to be a profit target.
The attached chart shows a few key Fibonacci extensions off the first big move lower in EURUSD. The most popular profit targets are the 61.8%, 100% or equal wave, 161.8%, 200%, 261.8%.
The shorter-term trader trend follower may favor the pivot point approach. Pivot points provide objective levels in the direction of the trend based on three key prices, the high, low, and close.
Swing traders can benefit from weekly pivots but longer term traders can use longer term pivots like monthly pivots as well. In an uptrend, the R1 and R2 are classic targets and the S1 and S2 are downtrend targets. The biggest benefit to using pivots is that when the trend is clear, you can easily use pivots to bring a great: risk: reward.
Always Manage Risk First
Marty Gruss once said, "If you watch the downside, the upside will take care of itself." While we're taking a more calculated approach than letting the upside take care of itself, the message is that what every trader needs to focus on first and foremost is the downside.
When you look at the first two approaches, equal waves, and Fibonacci extensions, you can cut the profit target by a half or two-thirds and make that point your protective stop. Therefore, if your profit target is 600 pips you can set your protective stop at 300 pips at half or 200 pips at a third of the way away from the entry.
When looking at the pivot point approach, you can use the key levels of the pivot to manage risk. In an uptrend, where you're using R1 or R2 as a profit target, you can use the pivot or the S1 as a protective stop. In a downtrend, you can also use the topside of the pivot or the R1 as the protective stop.