Profit Targets and Expectancy For Active Traders
Most traders who start out learning day trading or short term trading tactics tend to focus on the entry method the most when they first start out.
There have been countless studies to prove this point and if you doubt me just go online or take a look at a trading magazine and you will see articles and advertising for entry methods that produce high percentage of winners to be the most popular topic online and offline.
There is a fundamental reason behind this and companies who sell trading education and software know about this and take full advantage of this every time they can.
Need For Control
When traders start out they perceive markets differently than professional traders do, especially when they are starting out or just learning day trading methods. The beginner believes that with the right entry method they will gain some control over the outcome of their actions.
If you think about this on a deeper level you will see that that the only control traders have over their positions occurs at the time of entry. Once the position is entered and filled the trader loses all control over the position and is at the mercy of the market to do what the market is going to do.
Before entry the trader had full control over everything, the position, the account and even the market. Yes, you control what the market will do TO YOU by avoiding market entry.
So looking from a pure psychological perspective you can see how you give up all control when you pull the trigger and enter the position.
When traders look for entry strategies they focus on the accuracy of the method and the risk to reward profile of the entry method, this makes them feel in control over their trading account. They feel if they know how accurate the entry method will be they can have even more control over the market.
Most of the time this happens on a subconscious level and traders don’t even realize this is happening to their thought process but it is.
Exits Are The Key
I always ask traders how much time they spend thinking about their exit strategy compared to their entry strategy and the answer is usually 9 to 1. Think about your personal experience and how much time you think about your exit strategy compared to your entry strategy.
Most traders don’t spend nearly as much time thinking about their profit target compared to their entry strategy, but your profit target is responsible for how much money you make.
Same with your stop loss strategy; it’s directly responsible for your risk and your loss amount but most trading books talk about it in passing or provide simple rules that don’t work in all situations very well.
Positive expectancy which is the key to having a winning trading method.
They key to achieving positive expectancy is to minimize your losses and maximize your winners; both of these elements have to do with your Exit Strategy instead of your Entry Strategy.
You minimize your losses by placing stop loss orders that are effective without stopping you out prematurely and you maximize your winners by implementing a profit target or a trailing exit strategy that allows the market to maximize its momentum without exiting prematurely and missing out on a strong and powerful move in your direction after your position has been liquidated.
The ATR Indicator
Some time ago I wrote an article about using the ATR indicator to equalize or balance your positions. The ATR indicator measures the daily or the intraday trading range based on the actual volatility of the stock, futures or forex contract that you are trading.
Even though the ATR indicator was created 4 decades ago it remains one of the most solid indicators for measuring the current volatility. What I like the most about the ATR indicator is how it adjusts dynamically as volatility changes bar by bar or day to day, depending on your time frame.
This allows the market to tell us where to place stop loss orders and profit targets instead of us imposing our will on the market.
Things To Keep In Mind
I will continue this series and will show you exactly how to use the ATR indicator to measure stop loss levels as well as profit target levels dynamically based on the actual volatility of the market being traded.
Trading is not a one size fit all endeavor and different markets produce different levels of volatility at different times. By using actual market volatility to measure our stop loss levels and profit targets we give our positions the breathing room they need and at the same time the protection level necessary to achieve the best risk to reward ratio.
This is the best way to start learning day trading and swing trading techniques that will work effectively in the long run.