Do you often find that your trades go partway to your target and reverse? Or that your profit target is rarely hit, even if you do have a good initial entry point?
Is this because you are wishing for too much from your trade? Or is there something more in play?
My experience, both in my personal trading and with the signals, suggests that the answer is a little more complex.
It depends on a number of factors, some of which we will explore below.
How to tell what to expect from a trade using the ATR
The Average True Range (ATR) indicator is a tool that can be employed by day traders to determine the opportunity for that day.
The idea is that you can expect a currency pair to move a certain distance each day on average. If the market has already moved a certain distance, or if your target is outside of the extremes of its average daily move, then perhaps your target is set too far out.
Market turns during the UK and US sessions
It is also worth noting, for day traders, that markets can turn on a dime during the UK and US sessions. What may look like a promising start to a trade part way through the day can quickly reverse.
It pays to watch for these reversals (I use simple candle stick patterns) and then respond to them by taking some profit if you want to hold on to your gains.
Your targets will eventually get hit in a trending market
My experience suggests that if you are trading counter-trend, or if the market type is sideways, then your targets generally need to be much closer.
In a trending market, it is different. You can easily have targets that are at three times your risk and expect them to be hit often. (These would be ‘3R’ trades, in terms of R-multiples.)
Make sure you identify the market type, and set an appropriate target based on the likelihood of the trend continuing.
The key to this is using a higher timeframe.
Assess the opportunity on a higher timeframe.
When assessing the market type to see if you should have a close or distant profit target, you need to go to a higher timeframe.
I generally like to look at the daily charts for this, though 4-hour or weekly charts are appropriate as well (depending on your approach). While it is important to assess the market type on your trading timeframe, when deciding where to put your target you need to have a big picture overview.
If the market is trending in your direction on the daily charts, then your target can be further away and it is still likely to be hit. This does not mean it will be hit on the same day, rather eventually the market should trade there.
This means that if you are a day trader and the market is in a trend, perhaps you leave a little bit of your position to run.
The pitfalls and benefits of trailing your stop
The markets very rarely go in a straight line to your profit target. More likely is that price action will chop around along the way.
One of the key reasons that targets don’t get hit is that your trailing stop is too tight. A tight stop does not give the trade room to breathe.
If your target is further out and you want it to be hit, you may need to be prepared to forgo a trailing stop or (and this is my favoured method) trail the stop on part of your position only.
Be prepared with a scale out approach
What we do in our signals to counteract these issues is employ a scale-out approach. We generally employ three targets, and scale-out one third of our position on each one.
This leads to a much more consistent performance than if we used only the one distant target.
You may find that you benefit greatly from taking a little bit when the market makes some available, taking some more at a target that is likely to be hit, and then leaving a little to run in a trending market with a wide stop.
Don’t overemphasise a specific risk/reward ratio
Don’t get too caught up in thinking about needing a specific risk/reward ratio — rather, look at the market and devise something based on what the market typically does. This is to say: trade what you see in front of you.
You always want to keep in mind your risk/reward on your positions, but don’t think that having distant targets is the panacea that will solve your difficulties. The markets are subtler than that.
Understand what is appropriate for your trading style
The general “rules” above are not one size fits all.
Longer-term traders are going to require a different approach to shorter-term traders, and then day traders will need a different strategy yet again.
Make sure you are very clear on your trading style, and what you are trying to achieve, then pick profit targets that are appropriate to you.
About the Author
Sam Eder is a currency trader and author of the Definitive Guide to Developing a Winning Forex Trading System and the Advanced Forex Course for Smart Traders (get free access). He is the owner of www.fxrenew.com a provider of Forex signals from ex-bank and hedge fund traders (get a free trial). If you like Sam’s writing you can subscribe to his newsletter.