The majority of new traders usually focus most of their time on entries and entry methods, often overlooking targets and exiting trades. When you take the trade exit into consideration, you can judge the entry and your whole trade in a meaningful way. In this article we will compare the Fixed target approach with the trailing stop technique, take a look at the pros and cons and point out a few things you should know in order to pick the right approach for your futures trading.
The Fixed Target Approach
Most traders follow the fixed target approach where they have a predefined price level for their trade exit and take profit order upon entering a trade. Below, we will briefly introduce the 4 most commonly used fixed target techniques and tools before we get into the pros and cons.
4 ways to use Fixed Targets
Support and Resistance
The most commonly utilized way to set targets is by picking support and resistance levels. Those can come in the form of regular, horizontal support and resistance, or round-numbers, previous swing highs and lows and similar techniques.
The benefits of this technique is that it works for both trending and ranging markets, whereas other methods work better for specific market conditions.
The Fibonacci extensions can come in handy especially when trading trending markets. With the help of the Fibonacci tool, it is possible to choose entry points (usually the break of the 100% Fibonacci level) and then use the Fibonacci extensions to exit trades.
ATR (Average True Range)
The ATR is a volatility indicator that adjusts based on the price range and momentum. Typically, a trader would look for the maximum ATR target over a given period and then set his target ahead of the ATR projection.
With this method, a trader always places his target the same way, based on a predefined value of points or pips. The amount of points is chosen by the trader and based on the method he is trading and usually all his trades use the same target distance. Such trading strategies typically also follow the same principles for stop placement to achieve a consistent reward:risk ratio.
Pros and cons of the Fixed Target Strategies
Having fixed targets removes some of the emotional aspects of trading. A trader who sets his targets when he enters a trade is less likely to respond emotionally to price movements. Determining targets before you enter the trade is often done with more objectivity and without the pressure of being in a trade. A Futures trader can determine whether he wants to be in that trade based on the risk/reward it offers.
The downside is that the fixed target approach limits the upside on a trade. If the trader catches a runner but then exits based on his fixed approach, he is potentially leaving money on the table. This is the only and the biggest downside of using fixed targets. The common phrase that you should let winners run is somewhat limited following this approach.
The placement of contingent orders by you or your broker, or trading advisor, such as a “stop-loss” or “stop-limit” order, will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders.
The Trailing Stop Approach
Traders who don’t have a fixed target upon entering a trade usually use a trailing stop loss approach or respond to price action and price behavior to exit their trades manually. Here are the most commonly used techniques to set a trailing stop.
3 ways to use Trailing Stops
Moving averages are probably the most commonly used tool when it comes to trailing stops. Usually, the trader chooses his moving average and then simply trails his stop loss along the moving average as the trade progresses.
However, the question of which period to use for the moving average is the big unknown and it determines how vulnerable the position is to retracements and pullbacks. At the same time, this method works primarily for trend trading and is not suited for range traders in our opinion.
Support and Resistance
In this approach, traders look for support and resistance levels and/or swing points on their charts and then trail stop loss orders along the way once such levels are broken. The downside is that it is usually fairly easy to estimate where stop clusters will be located around swing points and traders should give their stops some ‘room’ to account for such stop runs.
In this context, traders can also use indicators such as Bollinger Bands or Donchian Channels to trail their stops.
Manual Profit Taking
Many traders choose to let their trades run until they see a price action signal or price pattern that would signal a reversal against their position. Such traders usually don’t trail their stop loss but only look for price action information to exit their trades.
Pros and Cons of the Trailing Stop Strategies
The advantages of using an open-end take profit strategy is that your upside is potentially not limited and you can, potentially, maximize your profits if you catch a runner trade.
However, such a strategy can be emotionally challenging because retracements and pullbacks can be quite significant and a futures trader who trails his stop loss too close risks being taking out during what is just a retracement.
A trader who isn’t disciplined is more likely to cut his winning trades if he does not have a fixed target and has to monitor his trades more actively.
The fixed stop loss approach is therefore better suited for beginner trader. We recommend that only seasoned traders follow the open-end, trailing stop methods because more experience is required in implementing such open ended trading strategies.
There is a substantial risk of loss in futures trading. Past performance is not indicative of future results.
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