A profit target is one of the ways that we can exit a profitable trade. Another option is a trailing stop loss. In this article, I am going to focus on the profit target. I use profit targets on most of my stock swing trades because it gives me a clear-cut exit point, lets me assess my reward-to-risk ratio before the trade, and I don’t need to do much once I am in a trade.
When I’m in a trade, I let the price hit my stop loss or profit target, and that is pretty much it. Once the price is well into the profit you could move the stop loss to slightly better than break-even. That is up to you. For the most part, with a profit target, you just let the price hit your target or stop loss. Over many trades, the reward-to-risk should compensate for losses (with a good trading method).
A profit target is a sell order, if you bought shares initially. You place a sell limit order at the price you want to get out at (See Order Types for more on orders).
For a step-by-step video guide on how to swing trade stocks, check out my Complete Method Stock Swing Trading Course.
Swing Trading Profit Targets and Reward:Risk
Over the last few years, I have only taken stock swing trades with at least a 3:1 reward:risk. If I am risking 5% on a trade (the difference between the entry point and the stop loss), I expect to make at least 15% on that trade (the difference between the entry point and the profit target).
This means that even if I only win 3 out 10 trades, I am still profitable. The goal is to win much more than that, but it’s nice to know that even a string of losses can be made back with a couple of winners.
3 winners x 15% = 45% in gains
7 losses x 5% = – 35% in losses
Here’s where it gets a bit tricky. I don’t just put my profit target at 3x my risk. I look at how the stock has moved in the past, how strong it is, and how far similar trade setups ran after entry. Based on this, I may find that a trade is unlikely to hit a 3:1 target, or I may find that I can set my profit target at 6:1 reward:risk, or even more.
If I don’t think the trade can produce 3:1 or greater, I don’t take the trade.
Basically, I set my profit target at a price that can be reasonably hit based on the stock’s tendencies. I then shave a bit off the estimate to be conservative and increase my chances of getting out with a profit.
Using this conservative profit target, the entry point, and the stop loss, I can then determine my reward:risk. As mentioned, it needs to be 3:1 or greater.
My profit target is based on what the stock is telling me at the time of the trade. The stock could keep running after it hits my profit target. I don’t care, and I may not even know because once I am out of a trade it is no longer on the charts in front of me.
I take my profit based on the stock’s tendencies. I then put that capital to work in another stock. In that way, if the stock does keep running, I’m not really missing out. I prefer to lock in gains regularly. That is how I like to trade.
Let’s look at some examples.
Swing Trading Profit Target Examples
Amazon was a leading stock coming out of the Covid-19 selloff in 2020. After a quick drop in February and March, it rallied to new highs and formed a nice handle in April through early June. With the cup and handle strategy, we want to see contracting price waves and then a consolidation with lower volume.
Looking at prior breakouts from consolidations earlier in the trend, we can see the price ran 19% higher from the higher consolidation and about 24% from the lower one before having a sizable correction or stalling out. This is the distance it ran before having a pullback or an extended sideways price move.
Therefore, a conservative target is 15% above the entry point being considered (consolidation). 20% would be a more aggressive target based on the prior moves. You could split the difference and put it at 17% above the entry.
This trade—with an entry above the consolidation, a stop loss below the consolidation, and a target 17% above the entry— provided a 5.3:1 reward:risk. That is why I like waiting for a tight consolidation because our stop loss can be relatively close, which means even with a conservative target we can have nice reward:risk trades.
The target is the top of the green box.
Charts from TradingView.
It doesn’t matter that the prior patterns may not have fit our exact strategy. We are just looking for an estimate of how far the price can run from a similar area when compared to the entry area we are considering now.
The price ended up moving past the profit target. That’s ok. I am totally fine missing out on a few percent profit in favor of jumping into a different trade that could quickly produce 20%, 30%, or more.
Following this trade, another trade set up. When a “handle” occurs well outside a “cup”, I call it a continuation pattern. Here we have a continuation pattern, and we still have the same information. On prior occasions the price ran 19% to 24%, depending on the entry point. And the last run higher went 32%. On this next trade, I still prefer to be conservative…putting a target near 17% to 20%.
With a 17% profit target, an entry above the consolidation (if the price moves above it…it did) and a stop loss below, this trade provides a 4.74:1 reward to risk. This trade went a big higher and then hit the stop loss. Losses can’t be avoided. That’s why we want our wins to bigger than our losses.
I really like trading newer stocks. I used to not trade them much since there wasn’t a lot of chart data to look at, but over the last few years my biggest trades have been in new and smaller companies.
This trade was a small Canadian company, Else Nutrition (BABY). It formed a beautiful cup and handle. We look back at the history and see how the price faired when it broke higher out of a sideways period.
On this trade, I was quite conservative, putting my profit target at 50% above the entry point. Only about half of what the last rally was.
I entered at $1.15. Stop loss at $1.04. Target at $1.73.
$0.11 of risk for a $0.58 profit potential. 5.27:1 reward:risk.
As it turns out, I could have used a profit target more in-line with the prior move. A 75% target would have still been easily hit at $1.98.
Restoration Hardware (RH) was featured on the blog as a trade that was setting up. Once again, we have a beautiful handle that fulfills all the requirements we look for.
Here’s the orginal chart from back then.
With an entry on the consolidation breakout, the risk was about 6.5%, and the target was 23%. This provided a 3.53:1 reward:risk.
What I didn’t discuss in that original article was why I chose a 23% target.
Looking at some prior consolidation breakouts with somewhat similar setups we can see the price typically ran between 24% and 28%, with a bigger one recently of 45% (they don’t need to be exact, and the prior entries don’t need to be perfect, we are just getting an idea of how far price is running). Therefore, I reasoned a 23% target had a good chance of being reached on the consolidation breakout I was trading.
I close trades prior to earnings (The Es along the bottom of the chart). If this trade hasn’t reached the target by then, I close the trade before the earnings are released.
On this trade, I expected to hold the trade through a bit of choppiness, because if you look at a few of my prior measurements, they included a bit of choppiness. By looking at how the price has moved prior, this helps you know what to expect. A few of those prior percentage runs lasted almost two months. So I knew going in this trade could take that long.
Here’s one more example.
Why This Profit Target Methods Suits My Trading Style.
I don’t hold trades through earnings, so I am going to be in a swing trade for approximately 3 months or less. I also don’t like holding through long sideways periods or big pullbacks. Therefore, that’s why I measure price moves the way I do. If can get out before a big pullback or sideways period, that is great. Basically, I am measuring how the price moved in relatively quick bursts. That way, I can hopefully capture similar bursts.
This fits my trading style. This approach is not meant for profit targets on multi-year trades. I am capturing bursts of moementum, and then getting out. So knowing how those bursts of momentum have looked in the past helps establish what the next one could look like.
It is not a prediction! I don’t know if the price will get there this time, or if it will shoot way past. This method is a just a way to determine if a trade offers a reasonable reward:risk on its price action. Reward:risk over many trades is what determines profitability.
Based on your trading style, another method may work better for establishing your own profit targets.
Picking Trades Based on Profit Targets and Reward:Risk
Trading isn’t just finding a setup and then trading it.
I scan for potential trades two or three times a week. Maybe 20 or 30 stocks get written down and I take a closer look at these (these are often included in weekly market updates on this site). Out of those maybe one will produce a trade in the next day or two. Maybe two or three others are placed on my “watch closely” list where I have a chart of it up on my computer and wait for it to set up a bit more before placing an entry order.
That narrowing down process is critical.
As a general rule, a bigger reward:risk is favorable.
Another thing I consider is how long the trade could last. Explosive stocks will often hit a profit target quickly.
BABY had the potential to move 50%+ in a couple of weeks. I expected RH to move about 20% in up to a couple of months. These are very different trades. Trades that are likely to hit the target quicker result in greater compounding, because you now have your original investment, plus the profits, to invest in another trade.
A trade that could make 40%, but will likely take 6 months to do it, is worth less to me than a 20% profit target trade that is likely to hit that target in a week or two. With those quicker trades, I can potentially make much more than 40% with that same initial capital by entering several trades in that same 6 month period.
It isn’t just about profit potential, it isn’t just about reward:risk, and it isn’t just about the time spent in trades….it’s all of them. Compare and decide which trades you like best. Leave the rest. If you don’t like any, don’t trade.
Position Sizing, Swing Trading, and Profit Targets
Throughout the article I have used language like “Risk 5% to make 20%”.
I am talking about the risk and return on the capital invested in that trade.
This has to do with position sizing. It is a key element of trading and very important to understand for successful trading.
Final Word on Profit Targets and Trade Selection
Weigh and compare each trade to other candidates, and other opportunities you know are likely out there. When the market indexes are shooting up, I am not going to take a trade with 3% risk and a 9% profit target, because there are much bigger profits out there. I just need to find them. I want to find the trade offering a 50% potential return (based on the conservative estimate method) and 7% risk, for example.
The profit target is an estimate. I have absolutely no idea how far the price is going to run, and neither does anyone else I have ever met or seen. I just look are prior tendencies and stick with that. It works well for me.
I am not concerned if the price runs past my profit target. Ideally, it should. I take my profits and move onto the next opportunity. Some stocks will produce multiple trades as they trend over time. I prefer to get in and out instead of trying to hold through choppiness and corrections for a bigger profit.
Take what you like and incorporate it into your method. Leave the rest.
Cory Mitchell, CMT
For more on establishing profit targets, and to see how they fit into a complete swing trading method, see the Complete Method Stock Swing Trading Course.
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.