Profit Targets vs. Trailing Stops

[ForexArticles]

I'm reading through an advanced copy of a new trading book that will be out in two weeks. (For all of you who can't wait for Van's new book on position sizing – this isn't it, though I'm reading through that one as well… and it's worth the wait!). As I'm reading, I note that another luminary has jumped in to answer the age-old question about profit taking exits vs. trailing stops.

Here's the problem.

Determining how to take your profits in a trade is of paramount importance. In general, this part of your system is much more important than figuring out where to enter.

But there's a bigger problem.

Everyone wants a simple solution. People like black and white answers. Answers with "always" or "never" in them.

And, at last, the biggest problem:

There is no simple solution. Our exits, more than anything else, require lots of thought. And continuous assessment. There is no one best solution.

Now for the good news…

There are useful guidelines for optimum exits for most standard trading strategies. That's a relief. As I have written in this space many times before, the most useful way to approach profit taking exits is to make sure that they match your system's underlying beliefs – the reasons why your system works.

For long- term, trend following systems this means finding some way to stick with a trend. Trailing stops are quite useful here. In fact, using a profit target would harm the performance of many long-term strategies.

The other end of the spectrum shows us channel-trading systems where you take profits and reverse your position when a predefined channel is hit. There is no place for a trailing stop in this basic system.

Ah, but what about all of the systems that lie in between these two extremes?

Back in the day, when trend-following was king and long- term position trading was the only method getting any press, using a profit target or anything other than a trailing stop was considered heresy. And for that type of system, it probably is. But many folks read stuff that was written for a largely trend following audience (including some of Van's early work) and make broad conclusions that profit taking exits are never useful. Questions about this show up on trading forums (including Van's Mastermind forum) all the time.

But more and more, I see good traders and system designers using hybrid exit strategies to optimize their results. Taking partial profits is not heresy if the exit strategy helps to capitalize on the strengths of the system design. Markets, even trending ones, have become more choppy than ever before. "Three steps up and two steps back" has become the normal operation in many markets.

Trading professionals adjust for this by taking partial profits at pre-determined profit targets. They may let the rest of the position follow the trend. Or they might take the rest off at a higher pre-determined level. It all depends on whether the strategy is designed to capitalize on really big trends or not.

This brings me back to the book draft that I've been reading. Another seasoned pro who has made consistent profits in the markets talks about his exit strategy. He takes 1/3 of his position off at a small gain, just to put the trade in the black. He then takes 1/3 off when the trade has made a bit more than he risked. The last one-third is used to trail a stop and try to stick with a longer term trend.

D. R. Barton, Jr. is the Chief Operating Officer and Risk Manager for the Directional Research and Trading hedge fund group. D. R. has been actively involved in trading, researching, and teaching in the markets since 1986. D. R. has taught extensively in many investment areas including intra-day trading, swing trading, and cutting edge risk management techniques.

His writing credits include co-authoring Safe Strategies for Financial Freedom and co-creator and contributing author on Financial Freedom Through Electronic Day Trading.

[HockeyWain]

That's quite a wonderful article, It could be beneficial for newbies and other traders to get over the Profit Targets and Trailing Stops.

[Flintoff]

It’s very crucial to have these points accurate, but more importantly it’s vital that we learn to stick to them which is the most important thing. I haven’t been all that good at putting right TP or SL, but I guess I am not needed to be all that great either thanks to DailyPipssignal service, it’s pretty cool with been highly affordable while the accuracy level is just something else and is one of the simplest Forex Signal service I have used especially with sort of accuracy.