Profit targets

One of the dilemma for many traders is when to take profit. Identifying a good stock to enter and entering it at right time is part of the equation. Other part of the equation is how much to risk and when to take profit. Now like most questions in trading, there is no one right answer to it.

Traders are often told "let your winners run", but that is very general advise. One way to look at profit targets is by analysing the catalyst. Most catalyst like earnings, guidance raise or inside buying have a time and magnitude dimension to them, depending on where the catalyst becomes known in price cycle. So for example the earning effect in majority of the cases lasts only 2-6 weeks.

The other way to look at targets is by looking at what kind of moves stock make for a given period of holding period. If you look at a large sample or the complete set of stocks in traded universe and find the returns for them, you will probably get a distribution like shown below.




The implication is clear if majority of stocks have say 25% or less move in a year then probably setting target at 20% profit from entry might be one way to look at. Now if you have a better way to pick stocks and if you find over a large sample that your selection criteria gives you stocks where majority of them make 50% or less but more than 25% then you will set your target accordingly. As you know, that is one of the reason I continuously monitor number of stocks up 25% plus, 50 plus, 100 plus, and 300 plus on different time frames. Plus I have done similar data mining on past 40 year data to look at what is a realistic profit target for my kind of stock selection methodology.

On smaller time frames like those used by day traders such analysis can give you significant clues to what kind of profit is realistic on those time frames. Obviously, they need to have lower profit targets. Because of their chosen time frame, they have to be very good at spotting an opportunity early enough and get in and get out. If your average opportunity size is say 1 dollar, you better be good at entry and exit. Plus you must spot it very fast before the 1 dollar opportunity becomes 50 cents.

Most of the opportunities on smaller time frames are ephemeral, that is why many day traders are unsuccessful compared to long term traders. Many day traders implicit assumption that there is an edge in smaller time frame itself is debatable. Those who are successful on short time frame either use automated strategies or have a unique personal skill. That is the reason you will find so many trying to copy the Trader-X method , but few are successful. The missing element is the secret sauce "X" which probably Trader-X only has. That X is highly refined skill like that of sword master who can cut 50 apple in two in a minute or less.