Hi guys, hi from Andrea Unger! Today I’d like to talk about when to take profit in trading. Is it worth using a profit target? And can it be used in all strategies?
Is using a take profit useful in trading? The answer to this question depends on what strategy you are using. Generally speaking, using a take profit tends to provide some psychological relief, allowing to cash profits when they reach a certain level. By using a take profit, you can avoid giving the money back in case the market inverts and starts going against your position.
From a psychological perspective, I think it’s worse to have an open position that, after being in profit, starts to lose, so that the profits you made become smaller, rather than to close a position and then see the market going in the direction you were in the market. In this case, using a take profit actually helps, as it protects your profits from vanishing.
The use of the take profit depends on many factors, first and foremost the kind of strategy you’re using.
In a pure trend following strategy in which you enter at the breakout of an important level and you ride the trend, using a take profit would go against one of the first rules in trading, which is “let your profits run”. In this case, a take profit would cut the position, damage your trade and the very idea behind it.
But if I can’t use a take profit, when do I close my position in this kind of strategy? Considering only a scenario in which you’re making profits, if you trade on an intraday basis you obviously close positions at the end of the day. If, instead, you go overnight, you let the position go until you get an opposite signal. So, let’s say you’re long and, at a certain point in time, there’s a setup that says to enter short. Then, you just reverse your position and close it.
So, using a take profit in this case is not advisable. However, there are also situations when a take profit can help. This is the case with trend following strategies that are not pure, as they’re based on a swing trading logic. These strategies look for certain setups in which moves start but have only a limited possibility to develop. In that case, you can place a take profit at the level that generally shows to be good for that setup.
The same applies to counter-trend strategies or, rather, to strategies that are based on a situation when there is an excess in the market (i.e. a move that exceeds normality, such as a big drop or a big rise) and you suppose the market exhausted this move and will have a rest and bounce, and then you enter against the trend that has been shown.
In this case, as you’re trading a reaction, this reaction has a limited possibility to develop. Imagine you throw a ball on the floor and it jumps back. Of course, it won’t reach the sky, but will stop at a certain level due to the laws of physics.
This is similar to what happens in the market. Unfortunately, there are neither formulas nor equations that can tell us where the market will move. However, depending on the setup we trade, we can study each market to find out what level it generally reaches based on the previous move.
In this case, using a take profit is advisable. It allows you to catch the portion of move you expect to happen and then close your position.
In bias or seasonality strategies, using a take profit is advisable when, during the period when you expect the market to move in a certain direction, the moves exceed certain levels. You believe that that’s an excess in the standard move, so you close the trade. It’s not a very frequent event, but it can happen.
To sum it up, the use of a take profit depends on the kind of strategy you use. In trend-following, it damages the trade itself. In counter-trend strategies, rebound strategies and, to some extent, swing trading and explosive move strategies, the take profit can help, as it helps you capture the move you wanted to ride with your trade.
That’s it, I hope this post was interesting to you.
See you next time, ciao from Andrea Unger!