Choosing a profit target is a key part of your trading strategy – it requires you work out in advance exactly how much risk you are prepared to take for how much potential reward.
Profit targets are actually the most important part of your strategy, because it is not your entries where you make a profit or loss, it is your exits. You need to be able to determine a suitable profit target for your trading – one that gives you a realistic profit target, but also gives you a sensible risk to reward.
There are countless ways in which you can set your profit target using technical indicators and other tools. We will show you two easy ways to set your profit target: support and resistance, and daily range levels using the ATR indicator.
Using support and resistance to set profit targets
Support and resistance is a powerful concept used by traders to read and interpret price action. It is based on the theory that the price may struggle to break above certain resistance levels or below certain support levels. You can use this to determine profit levels.
Using resistance
If you are in a long trade, key resistance areas can be a good place to set your profit target levels. If you are in a short trade, support areas can be a good place to take profit.
The chart below shows an example of how resistance can be used to take profit when you have a long position and prices are moving upwards in your favour:
As you can see in the chart above, after the initial entry into the market comes a favourable move up to a level of resistance. At this point the price begins to stop and may even reverse direction.
In this example, you should look to take profit where the price first reaches the level of resistance.
Using support
The chart below shows an example of how support can be used to take profit when you have a short position and the market is moving down in your favour:
As you can see above, after the trade is entered, the price moves downwards to a level of support. At this point the price struggles to break below the support level and may even reverse.
In this example, you should look to take profit where the price first reaches the level of support.
Different types of support and resistance
Support and resistance is not confined to horizontal support and resistance only. For instance, you can use pivot points, trend lines and channels as they all present support and resistance in one way or another.
What you are essentially doing is finding out where the price is likely to stop and taking your profit at that point.
Using daily range levels to set profit targets
Another effective way of working out your take profit levels is by using daily range levels.
To identify daily range levels, you can use the average true range tool. This tells you exactly how far you can expect a price to move on any given day based on recent price movements.
Apply the average true range (ATR) indicator to your daily price chart, as shown in the image below:
For a long trade, once you have entered your trade you can use the value of the ATR to place your take profit away from your entry.
The image below illustrates this process:
For a short trade, once you have entered your trade you can use the ATR value to place your take profit away.
The image below illustrates this example:
The importance of risk to reward ratios
A risk to reward ratio is a measurement of how much profit you are anticipating in exchange for the maximum potential loss you can suffer.
When setting your profit targets it is very important to trade with a positive risk to reward ratio.
When a setup occurs that does not offer an appropriate risk to reward ratio, it is always best to leave the trade and wait for a more profitable scenario later on.
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