Setting a Price Target is part of a good trade plan.
We spend a lot of time discussing why “trading with a system” is a superior approach in today’s market here on the blog and on our weekly Live shows, so today I wanted to talk about setting price targets. By now I’m sure you realize that using a systematic, mechanical approach to trading is the key to consistency and success.
In addition to using stops loss orders – as I’ve written about at length here in other articles – we’ve found that also setting targets gives you an edge. The old saying “no one ever went broke taking a profit” still holds true and makes a lot of sense.
You need to have a profit taking strategy. This is where setting a price target for each trade comes in.
The great thing about Price Targets is that it’s like setting a goal. Without having a “goal target” you run the risk that a stock makes a nice move in your favor, you don’t take any profits and then the stock drifts back down to where you bought it – or worse – it turns into a loss.
Determine a reasonable price target on every trade – and be ready to lock-in some profits when your stock hits that target.
You’ve probably read some articles that are against setting targets because they say you are “limiting your gains”. That sounds like it makes sense at first – until you have a few stocks that rip higher and you never locked-in any profits – only to see them quickly reverse and leave you with that “I should have sold some” feeling. We’ve all been there.
You don’t have to sell your whole position at your Price Target.
In my experience, using a scaling-out approach is one of the best ways to maintain the proper mindset when swing trading. When I talk about setting a target for a trade that doesn’t mean it’s an “all-out” target. It’s simply a goal you set where you will lock-in some profits (which reduces the cost basis on any remaining shares) and goes a long way to improving your mindset.
Think about this. When you buy a stock and you “set a target” you can program a GTC (good till canceled) sell order at your broker and you don’t have to worry about watching your trade like a hawk. We’ve all seen those crazy intra-day spikes out of the blue that would have been perfect profit-taking opportunities – but often times they reverse or fade just as quickly. If you have a GTC sell order in at your broker you’ll catch those big price spikes when they happen. If you don’t already have a Target set then you are going to miss out on that every time.
So how do you figure out a good price target?
That’s where it can get a little tricky. A good price target has to be close enough to your entry so that it has a “high-probability” of getting hit. Remember, the target is a “goal” and just like setting goals in life, you want to make sure they are realistic and can be achieved. Think of how good you feel when you set goals in other areas of life and then actually accomplish them. It’s a good feeling. Same thing with setting goals (targets) on stocks.
Price targets can be set in a number of different ways.
Most Wall Street firms publish what they call “price targets” on stocks they cover based on fundamentals. Their target price is an estimate of a stock’s future price, based on earnings forecasts and assumed valuation multiples. You’ll often hear on CNBC that “so and so raised their price target on Apple”. But we are technical traders and this doesn’t make sense for swing traders and our type of trading.
Since we are using charts and price patterns, identifying a clear level of resistance on the chart can be one way of setting your target. Maybe your stock has a habit of rallying up to a certain area and then pulling back afterwards. You might consider setting your target just below that zone of resistance. Say a stock is trading in a channel and each time it gets near the top of the channel it pulls back, setting your target near the top of the channel makes sense.
Sometimes support and resistance levels on the chart are easy to spot and other times they aren’t. In many cases “resistance” is extremely subjective.
The methodology we use to determine our target is based on the ATR of the stock. This provides consistency and at the same time it is adaptive to each individual stocks behavior.
We’ve found that using a monthly ATR works best (a larger data set than the standard 14-day ATR) and setting our target just shy of 3 ATR’s gives us a high-probability hit rate. Targets are there as a predetermined level to lock-in profits so we want to be sure they have a high degree of success.
Take a look at this table of our Closed Trades that were opened in October. I’ve circled the “maxprice” column which shows the highest price the stock hit after triggering in a trade. This is compared to the Target column and I put a check mark next to each stock that hit the target.
You can see that many times the stock went well past the target but that’s not what’s really important here. The idea is that the Target is there for a reason – it’s the ideal spot to lock-in profits. And as I mentioned earlier, this doesn’t mean you have to “sell all” at the target. We actually recommend selling half the position at the target and using the trailing stop to exit the rest.
For tracking purposes our system only closes a trade when it hits the trailing stop.
Notice that MLHR actually hit the Target, but then faded back down to the trailing stop which took us out at about breakeven. It’s the perfect example of why taking some profits at the Target is a good strategy.
If you lock-in half your profits at the target and your stock continues to rise, then you are still in – with a half position. That way you don’t fret and think to yourself “I should have held on to the stock” because trust me – there will be plenty of times you’ll think “I should have sold some when I had the chance”.
Setting a target is like setting a goal and helps remove emotions from your trading. It’s part of a good trading plan.
Used in conjunction with a trailing stop-loss, it gives you an edge and provides the perfect framework for trading. Think of it this way. You enter a trade and immediately place your initial stop and at the same time enter a GTC sell order at the target (half or all of the position). Now you can just go on about your business and let the trade play out over time – without having to babysit it, watch the chart all day or worry about what you will do after the stock moves. There’s no “changing your mind” mid trade or second-guessing anything.
Entries, stops and targets are the keys to successful swing trading and it’s important you have these all planned out in advance. Anything else is “just winging-it” and that’s definitely not the way you want to approach trading.
Using a consistent strategy and a methodical, systematic approach is the key to successful swing trading.
That’s actually what our system is designed to do and I invite you to try it out and let our software do the heavy lifting for you. If you like what you see on the Closed Trades table above, click here to try our swing trading service and let the power of our systematic approach work for you.