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How To Place A Stop Loss & Profit Target Like A Professional (Part 2)

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by , 05-20-2014 at 02:32 AM (1968 Views)
Quote Originally Posted by matfx View Post
Placing profit targets

Placing profit targets and exiting trades is perhaps the most technically and emotionally difficult aspect of trading. The trick is to exit a trade when youíre up a respectable profit, rather than waiting for the market to come crashing back against you and exiting out of fear. The difficulty of this is that itís human nature to not want to exit a trade when itís up a nice profit and moving in your favor, because it Ďfeelsí like the trade will continue on in your favor and so you donítí want to exit at that point. The irony is that not exiting when the trade is significantly in your favor typically means you will make an emotional exit as the trade comes crashing back against your position. So, what you need to learn is that you have to take respectable profits of 1:2 risk:reward or greater when they are available, unless you have pre-determined before entering that you will try to let the trade run further.

General profit target placement theory:

After determining the most logical placement for our stop loss, our attention should then shift to finding a logical profit target placement and also to risk reward. We need to be sure a decent risk reward ratio is possible on a trade; otherwise itís really not worth taking. Now, what I mean by that is this; you have to determine the most logical place for your stop loss, as we discussed above, and then determine the most logical place for your profit target. If after doing that, there is a decent risk reward ratio possible on the trade, itís a trade thatís probably worth taking. However, you have to be honest with yourself here, donít get into a game of ignoring key market levels or obvious obstacles that are in your way to achieving a decent risk reward just because you want to enter a trade.

So, what are some of the things I consider when deciding where to place my profit target? Itís really pretty simple, I am basically analyzing the overall market conditions and structure, things like support and resistance levels, major turning points in the market, bar highs and lows, etc. I try to determine if there is some key level that would make a logical profit target, or if there is some key level obstructing my tradeís path to making a decent profit.

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Now, letís take this a step further and put everything weíve learned in todayís lesson together. We are going to analyze a trade setup and discuss the stop placement on the trade, the target placement and the risk reward potentialÖ

In the chart below, we can see an obvious pin bar reversal setup formed near a key market resistance level, indicating that a move lower was a strong possibility. The first thing I did was determine where best to place my stop loss. In this case, I elected to place it just above the pin bar high since I determined that I would no longer want to be short if the market moves up to that level.

Next, I noticed that thereís a key support a little ways down below my entry, but since the key support didnít come in until almost 1.5 times my risk and beyond that there was no key support until much further below, I decided the trade was worth taking. Given there was a chance of a reversal after the market hit that first key support level, I pre-determined to trail my stop down to that R1 level and lock in that profit, if the market reached that level. That way I can at least make 1R whilst avoiding the potential reversal off that key support.

As it turned out, the market sailed right through the first key support and then continued moving lower to make 3R. Now, not every trade is going to work out this well, but I am trying to show you how to properly place your stop loss, calculate what your 1R risk amount is and then find the potential reward multiples of that risk whilst considering the overall surrounding market structure. The key chart levels should be used as guides for our profit targets, and if you have a key chart level coming in before the trade can reach a 1R profit, then you might want to consider not taking that trade.

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When we are trying to figure out if a potential price action trade setup is worth taking, we need to work backwards to some degree. We do this by first calculating the risk and then the reward and then we take a step back and objectively view the trading setup in the context of the market structure and decide whether or not the market has a real shot at hitting our desired target(s). Itís important to remember we are doing all of this analysis and preparation prior to entering our trade, when we are objective and unemotional.

Note: There are different entry possibilities that I didnít get into here which can affect the potential risk reward of a particular trade setup. Todayís lesson was just meant as a general guide of how to logically and effectively place stop losses and targets on select price action trade setups, I discuss different entry scenarios and more trade setups in my trading course and membersí community.

Final note:

A trader is really a business person, and each trade is a business deal. Think about Donald Trump doing a big business deal to buy a new hotel developmentÖhe is carefully weighing the risk and the reward from the deal and deciding if itís worth taking or not. As a trader, thatís what we do too; we first consider the risk on the trade and then we consider the potential reward, how we can obtain the reward, and if itís realistically possible to obtain it given the surrounding market structure, and then we make our final decision about the trade. Whether you have a $100 account or a $100,000 account, the process of weighing the potential risk vs. the potential reward on a trade is exactly the same, and that also goes for stop and target placement; itís the same no matter how big or small your account is.

Our number 1 concern as traders is capital preservation. That means getting the most Ďdistanceí out of our trading capital. Professional traders do not waste their trading capital, they use it only when the risk reward profile of a trade setup makes sense and is logical. We always have to justify the risk we are taking on any one trade, thatís how you should think about every trade you take; justify the money you are laying on the line, and if you canít make a good case for risking that money given the setup and market structure, then donít take the trade. Each trade we take needs careful planning and consideration and we never want to rush to enter a trade because itís far better to miss an opportunity than it is to jump to a conclusion that we came to emotionally rather than logically.

Article Written by Nial Fuller

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