Should we set profit targets? by Darren Winters
Many investors like to have a complete plan of how they are going to trade and what profit they would like to make each month. It’s easy to understand why; many courses and books discuss making 5% a month or 20% a year or whatever figure they choose to aim towards. Even we have discussed the power of compounding in the past and shown what a return like 5% a month can do to a portfolio over just 3 or 4 years.
The problem with planning profits in advance is that you can’t rely on that steady rate of return, so is it even worth setting such goals? To give you an example; would you rather have profits over three months of 10%, 10% and 10%? Or would you prefer to take a more unpredictable scenario of –10%, 50% and 28%?
Assuming the target of 10% for three months and you started with £10,000, your capital will have compounded to £15,208. But if you had opted for the more unpredictable returns, your capital will have grown to £17,280 even though you lost money in the whole of the first month.
LET THEM RUN
The key here is to let your winners run. If you exited a trade just because it met a price objective, it could have continued going in the right direction and thus, an even more profitable trade was closed early. Think of it this way, why would you want to exit a trade at a 10% profit when it could go on to make 60% or 100%?
Now we are not saying wholeheartedly that you should not set price/profit objectives, we do this all of the time with our trading. But if a trade gets to a target area for you, you may want to close half of the position to lock in profits along the way. By doing this, you have the best of both worlds. Part of the gains are banked whilst you still give the position room to run further if it wants to.
If you consider that stocks trend 80% of the time, once you have gotten onto that trend, why would you want to totally jump off? I guess you could have a very slow moving stock and you may want to move into something that has the potential to move quicker. But if you know a trend is in place, you should certainly try to stick to it. As an example, lets say you believe that the dollar will fall in value against the pound over the next year to over $2.
Once you have identified your entry point and the trade is moving in the right direction, there is no need to exit. You can take profits off the table along the way, or even add to your winning position using your paper profits as collateral. The way to do this is that as you move your stop/loss behind your trade, you would be locking in profits anyway so a strategy could be to add to the position periodically.
Knowing that stocks trend for 80% of the time and go nowhere for the remaining 20%, it allows traders and investors alike to make small losses when a market is in a trendless environment. Subsequently, it enables them to more than make up for those losses when a larger trend gets underway.
An essential part of trading trends is being prepared to weather small losses or occasional sideways moving markets. If you do not think you could cope through these periods, you will never be able to stick to the right strategy.
Because no traders can predict what is going to happen next week or next month with 100% accuracy, it is not easy to know whether you are in a trend or if a stock is about to move sideways. For that reason, what appears to be a trend can fail. As a result of this, every buy or sell signal that you see using your strategy should be acted upon. If you try to second guess which trade might work out and which won’t, you could miss the trades that make sizeable profits.
THE BENEFIT OF HISTORY
By ensuring that you trade all buy and sell signals that are created using your strategy (whether it is one each week or only one every 2 months) you ‘know’ future profits will be generated. Just back test your strategy and see how it would perform over time. It only needs to win 50% of the time in order for it to be successful. The key is to only take small losses on the occasions the strategy doesn’t work.
By back testing your strategy, you should be able to work out what is the best stop/loss to employ by identifying the point at which the strategy is going to go wrong. Any charting software with end of day data will allow you to back test any strategy you wish.
SUMMARY
Profitable trading and investing is all about letting your winners run, not cutting them short just because a profit target has been met. Even day traders will use this strategy in their intra-day trading, albeit on a shorter time scale.
As usual, the most important thing to do is to keep moving your stops up to lock in profit and also to sell part of your position once your original profit target has been reached. As shown earlier, the less consistent approach actually yields higher returns over the long run.
Darren Winters
The problem with planning profits in advance is that you can’t rely on that steady rate of return, so is it even worth setting such goals? To give you an example; would you rather have profits over three months of 10%, 10% and 10%? Or would you prefer to take a more unpredictable scenario of –10%, 50% and 28%?
Assuming the target of 10% for three months and you started with £10,000, your capital will have compounded to £15,208. But if you had opted for the more unpredictable returns, your capital will have grown to £17,280 even though you lost money in the whole of the first month.
LET THEM RUN
The key here is to let your winners run. If you exited a trade just because it met a price objective, it could have continued going in the right direction and thus, an even more profitable trade was closed early. Think of it this way, why would you want to exit a trade at a 10% profit when it could go on to make 60% or 100%?
Now we are not saying wholeheartedly that you should not set price/profit objectives, we do this all of the time with our trading. But if a trade gets to a target area for you, you may want to close half of the position to lock in profits along the way. By doing this, you have the best of both worlds. Part of the gains are banked whilst you still give the position room to run further if it wants to.
If you consider that stocks trend 80% of the time, once you have gotten onto that trend, why would you want to totally jump off? I guess you could have a very slow moving stock and you may want to move into something that has the potential to move quicker. But if you know a trend is in place, you should certainly try to stick to it. As an example, lets say you believe that the dollar will fall in value against the pound over the next year to over $2.
Once you have identified your entry point and the trade is moving in the right direction, there is no need to exit. You can take profits off the table along the way, or even add to your winning position using your paper profits as collateral. The way to do this is that as you move your stop/loss behind your trade, you would be locking in profits anyway so a strategy could be to add to the position periodically.
Knowing that stocks trend for 80% of the time and go nowhere for the remaining 20%, it allows traders and investors alike to make small losses when a market is in a trendless environment. Subsequently, it enables them to more than make up for those losses when a larger trend gets underway.
An essential part of trading trends is being prepared to weather small losses or occasional sideways moving markets. If you do not think you could cope through these periods, you will never be able to stick to the right strategy.
Because no traders can predict what is going to happen next week or next month with 100% accuracy, it is not easy to know whether you are in a trend or if a stock is about to move sideways. For that reason, what appears to be a trend can fail. As a result of this, every buy or sell signal that you see using your strategy should be acted upon. If you try to second guess which trade might work out and which won’t, you could miss the trades that make sizeable profits.
THE BENEFIT OF HISTORY
By ensuring that you trade all buy and sell signals that are created using your strategy (whether it is one each week or only one every 2 months) you ‘know’ future profits will be generated. Just back test your strategy and see how it would perform over time. It only needs to win 50% of the time in order for it to be successful. The key is to only take small losses on the occasions the strategy doesn’t work.
By back testing your strategy, you should be able to work out what is the best stop/loss to employ by identifying the point at which the strategy is going to go wrong. Any charting software with end of day data will allow you to back test any strategy you wish.
SUMMARY
Profitable trading and investing is all about letting your winners run, not cutting them short just because a profit target has been met. Even day traders will use this strategy in their intra-day trading, albeit on a shorter time scale.
As usual, the most important thing to do is to keep moving your stops up to lock in profit and also to sell part of your position once your original profit target has been reached. As shown earlier, the less consistent approach actually yields higher returns over the long run.
Darren Winters
posted by Darren Winters at 1:18 PM
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