When talking about trading financial markets, including currencies, “system” is almost always taking central stage. By “system” I mean set of rules that dictate when trader gets into the market, irrespective whether it is short or long position.  A lot of energy is devoted to finding perfect strategy, in most cases focusing on entry rules. Unfortunately, no trading method consists only of getting into the market. There are other elements that must be carefully incorporated into a system, such as money management, stop/loss and target, objective, setting rules. It is really amazing how many people overlook one or more of these variables, creating incomplete trading plans.

Everybody knows why stop/losses are important, even though a lot of us ignore this “obvious” knowledge in real life trading. But why targets, why are they important, if not instrumental to trading success? Well, we can’t be profitable unless we actually bank profits on our trades. This means we have to close them at price better that we got in( short or long). Since markets are in constant movement, we should know how far we expect them to move our way and try to take profit at predetermined point. Not that it will always happen the way we want, but we must have a plan in place, rather than getting into position and hoping to close the trade sometime in the future.

How exactly do we go about setting targets for our trades? There is no one simple answer, since many methods of choosing objectives are in existence, but in almost all cases exit strategies are directly dependent on entry systems. Among them:
- fixed number of pips, always trying to get same number of pips, like 20, 50, 100 or so;
- time based exits, closing trades at predetermined time, like end of a session, end of day, week or some variation;
- using previous resistance/support as targets;
- staying in trades for as long as trailing stops keep positions active. One such technique was described in Price action Forex trading. Using technical tool like Parabolic Stop and Reverse also suits this purpose;
- employing technical indicators to determine oversold/overbought levels at which to close trades;
- when using crossover strategies for trading, such as Moving Averages, or MACD, waiting for next one to happen. In cases like these backtesting provides some evidence of what can be expected;

Most of the trades I cover in this blog are discretionary in nature, but are largely what I call Swing trading. This is nothing more than analysis of most recent price swings. In very simple terms, “swing” is a distance price covers between high and low (or low and high, depending on point of view). Those highs and lows are also “pivot points” for price movements. Most recent swings are used as a tool to set targets for next moves.

Here is a simplified example of a price swing. Movement from point “A” to “B” is a “swing” with either one being a “pivot point” when price moves to the other side. In this example I will be discussing price reversal. After a down trend I think that move is running out of steam and will be changing direction. Going above most recent high (A) creates buy situation with “A” becoming a pivot point.

According to simplified swing trading theory, once pivot point is established, in this case it is minor high “A”, price should move on to its other side by by the same distance as it  reached before the reversal happened. In other words distance between “A” to “B”, our latest down swing, is the same distance by which price should move above the pivot point. This gives as projected target at “C”. Swing theory relies heavily on symmetry on the markets, but not like a mirror image, more like general guidelines.

One important note here, is that even though the distance from “A” to “B” indicates magnitude of probable swing above our pivot point, it really doesn’t say anything about how price is it going to get there. Will it be a straight move or a serious of smaller pulses, swings? At this stage we don’t know ( there are certain clues, but they can be complicated and out of scope for this introductory post).  For our purposes we focus on the fact that once price moves above “A”, it should reach objective “C” rather than going down to “B”. Should that happen, breakout is a failure, and we could use “B” as new pivot point for a move down.

Some people might be surprised that any one single swing could be bases for price projection. However, anybody who has even rudimentary knowledge or interest in technical analysis must have come across projections done from more complex  price patterns. Head and shoulders, cup with handle, saucer, rectangle, triangles and just about any other formation provides guidelines for how large the move should be, once price moves outside of the pattern. If you look closely, though, it should be noticed that it is not formation itself, but the largest price swing within it. The above example should make it clear. Any single swing provides objective for next move. It is better to trade a little more complex formations, but this goes under trade selection not target projection and will be covered at other time.

This is setting trading objectives using swing trading theory in its simplest form. For actual trading I employ few modifications and additions to these basic principles. Here is a chart of very recent trade set up that happened on 4H chart of NZD-CAD.

Price was moving down reaching about 0.7630 level, before starting to turn around. At this point I estimated that chances for reversal were high enough to start planning a long trade. Most recent high was at 0.7750,  “A”, which would become a pivot point, as well as my entry for a buy. According to rules outlined earlier, after moving above pivot point, one could expect price to proceed for about 120 pips, or roughly 0.7865. This calculation could be done manually, but a handy tool exists which makes marking objectives in a fast an easy manner- Fibonacci retracement/projection application. It is available in most charting packages.

Here it is in use. FIB tool marks the target where calculation would have, with precision and very expediently. We can see that objective for the move up, coincides with previous high at 0.7865. This is important, because resistance could be expected at this level, giving additional reason to get out, take profit, at our objective. Finding these kind of relations is one of the modification I try to do to original concept. At least one more reason why to get out at expected objective. It could be other things, too, like running into dynamic support/resistance (MA’s, or Trend Lines if I used them), round numbers or something like that. Another of my “improvements” is lowering the value of projection- making the target a little smaller.

Why? It should be obvious that using swung trading theory for that purpose doesn’t always work- nothing does. Trading breakouts suffers many false ones. This can be mitigated, to a degree, by trade selection, not covered here.  Another way to improve probability of trade reaching its destination is to make it smaller. After all, it is easier for price to move 10 pips, than, say, 100 pips. Not to mention faster. Question is, just how much smaller do we want to make our targets in order to increase the odds, but without passing on too much opportunity? Just like everything in trading it demands reaching certain balance, which is achieved through compromise of some sort. In this example I use about 2/3 of projected target for my objective. Still large enough chunk of original projection and should be reached much faster and with higher degree of probability. And it is very easy to calculate, using the same FIB tool, with 1.618 (1.62) setting. I still look for combination of additional reasons to close the trade at that level, as explained in previous paragraph. Chart above shows that this modified, yet more likely, objective would be around 0.7820.

This chart shows how price progressed from the point of analysis. Move indeed happened, went through entry level and reached both projected prices. I took profits at 0.7820, lower target.  The very same chart, 4H NZD-CHF is currently setting another potential buy signal, where the above described rules can be applied. Next chart is compressed, to include more price history.

After making a high at 0.7890, price fell to 0.7690 before making another run. As is right now, move above 0.7900 might be very tempting buy. Now, I don’t know if this will happen, or if I would take the trade. It depends on how active I’d be at the time. However, target for this trade would be at 0.8000. This is not only 1.62 FIB level, but also previous resistance as well as a round number. That’s what I’d be looking for should I find myself in this trade.

Most of the trades I feature in this blog are discretionary in nature, and not created by a rigid, inflexible system. This means that setting and waiting  for targets also has element of discretion. Sometimes I don’t wait until objective is achieved. For example, trade would be closed if it is taking too long, which was discussed in Predicting length of a trade. Emergence of ominous candlestick pattern can also be a reason to close position before target is met. On the other hand, if move is especially strong and fast, I can decide to extend objective. But for the most part I stick to the rules outlined here.

Certain issues have been left out for the sake of simplicity. I didn’t include stop/losses here, which has some effect on trade selection, but not so much profit target. Sometimes trade is simply forgone if ratio of S/L to T/P is unfavorable, but this is topic for another time. Trade objectives are the focus here. This relatively simple way of setting reasonable targets can be applied to any breakout technique, pattern trading and price action set ups. It can be easily modified to one’s personal method.

Mike K.