Description: When it comes to trading, both entries and exits are of paramount importance. While entering a trade at the most opportune moment ensures that the trade gets ample room to move, exiting a trade at just the right time ensures consistent growth of your trading account.
While mastering the entries give you an edge in your trade executions, it is the exits that complete the other half of the trading puzzle!
In this article, we will discuss two profit taking techniques i.e., fixed profit targets and trailing stops and have a look at their pros and cons.
Fixed Profit Targets
As the name suggests, a fixed profit target is a predefined price target determined by the trader right at the outset of entering into a position. It helps him to have a clear cut pathway chalked out before him while trading.
These fixed profit targets could either be based on Fibonacci ratios or Risk/Reward ratios.
For example, a trader employing Fibonacci ratios could decide to go in for a fixed profit target at the 100%, 127.2% or 161.8% extension level of the prior swing to take profits.
On the other hand, a trader following a risk/reward pathway would take profits at a predefined price level that is X times the risk he takes for the trade. While some traders follow a 1:2 risk/reward ratio meaning for every one rupee being risked they would consider a 2 rupees profit, there are some others who wouldn’t trade unless they get a favorable trade setup providing as high as a 1:5 or higher risk/reward.
Fixed profit targets are great for taking small and consistent profits and are more suitable for active traders. However, in case the fixed profit is not reached and the trade doesn’t unfold as expected, the trader carries the risk of losing money.
Ever heard of the saying – “Cut short your losses, let your profits run”? This old piece of wisdom has been passed over generations and still holds true in today’s markets. The beauty of trailing stops is that they let you ride the big waves in the market as and when they happen. However, during range bound markets, they are not of much help.
Trailing stops are more suitable for passive traders who are looking to ride the big moves in the market following consolidation breakouts. The most important aspect of using trailing stops is that they help you to maximize your profits when you are right to take care of the small losses when you are wrong. It acts as a cushion to the drawdowns that every trader experiences during their trading career.