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Hello everyone, I'd like to gain a better understanding of setting up profit targets (PTs) before entering trades. I've been studying Al's methods since last year, and I've read his books and watched his videos. I'm currently in the process of developing my trading edge. One of the key points Al mentioned is that the single most important edge to have is a reward that is at least twice the risk. However, I've found it challenging to achieve this, especially on trading range days. As a result, I've made some adjustments to my reward requirements as follows:
- When trading with the trend: A 1:1 Risk/Reward (R/R) ratio.
- When trading against the trend (counter-trend): A 2:1 R/R ratio.
As for setting my PT's for trading ranges, I'd like to ask if you think it's reasonable for me to aim for a 1.5:1 R/R ratio. My reasoning behind this is that trading ranges often have a 50-50 probability, and going for a 1:1 R/R ratio would likely be a losing strategy in the long term, especially considering fees. On the other hand, aiming for a 2:1 R/R ratio would require me to enter trades with limit orders, which I'm currently avoiding as a beginner.
I'm only using the R/R ratio as one of my prerequisites for deciding whether a trade is worth taking. I also monitor my trades closely and tend to exit early if they do not go in my favor or meet my expectations.
Thank you advance
This is just my point of view (I am not a professional trader yet). Lately I have begun focusing on trading major trend reversals. I am currently in the process of adding 2-legged pullbacks in trends and trading range reversals to my toolbox. I don't set profit-taking limit orders in the market for 2IR. The way I use the concept of 2IR is simply a measure of the minimum room needed before placing the trade. If there is not enough room for at least 2IR, I will not take the trade (e.g. tight trading range). This is for all 3 setups - major trend reversals, 2-legged pullbacks, and trading range reversals. If a trading range is too tight, it does not allow me to put on the swing position I would like, and therefore I will not take the trade (there are exceptions like a MTR top being in a TTR). Since I am swing trading, I am looking basically looking for a favorable surprise that creates a trend in my direction. If this trend does not come, I will exit for a scalp or loss. I do not use 2IR for exiting, I simply exit based on what the premise for the trade is, and if the premise is no longer valid, I exit. If I get a breakout and a trend, I try to hold for as long as possible. It doesn't have anything to do with 2IR.
Thank you Andreas for your reply and apologies for my late reply
Likewise, I am trying to start the same habit of setting my rule as only going into trades that have a 2:1 R/R, but I feel that there are too little setups with that rule, unless I start using a tighter stops (to be very honest, I am not sure if I am being impatient). Do you use tight stops? My usual stops are at the recent major high/low or start of a strong leg
I do not hold onto a trade if the market has an unexpected development from my perspective. As for holding for more profits, do you hold your full position after it hits 2:1 R/R or do you scale out some and re-enter if there's another entry?
This is the crux of my issue, I tend to either hold for too long, and if I scaled out, I find it hard to scale back in if there's another setup. I am hoping in time and experience I will be able to improve on this area
So the way I manage a trade is not going to be based on any risk/reward ratio. If we consider something like a major trend reversal setup, you are looking for a favorable trend. If you do not get the trend, your premise is not valid. You have to give the market some wiggle room, but you also do want a trade going bar after bar after bare etc. Otherwise don't spend your time and money on that trade.
There are plenty of major trend reversals that offer trends where you are not doubting if it is actually trend (at least in the DAX). If I am in doubt if the trend is strong (for example if I think a minor reversal will possibly grow major), I will exit and look to re-enter at the MA or on resumption. Managing a trade has nothing to do with risk/reward (my belief) or where you entered the trade.
(BTW, check out the past 20-30 MTR successful setups or so on your charts and notice there is usually a good signal bar, reasonable risk, early always-in reversal, favorable close on the entry bar, reversing some S/R level like yesterday's extreme, and if it is an index like the SP500 or DAX, it is usually midday or open. A favorable trend is usually respectful of the 20-bar EMA, and notice how many pullbacks actually come from relatively strong reversal bars - yet they fail to reverse the trend.)
I only trade setups where I expect a favorable trend (2-legged pullbacks in trends, MTR's, large trading range reversal etc.) because I can manage ALL my trades in the exactly same way. I don't care if I missed a move, I need a clear setup that is possibly the beginning of a trend before I take trade. I only trade a possible beginning of a trend if a tight stop is reasonable (good signal bar, good setup, and good context). Otherwise, I am not comfortable.
If a trend is protracted, I will be looking to exit at some S/R level. I don't want to hold through dozens of bars of TR price action. I don't scale out anymore but instead exit and re-enter when I am worried about a possible deep pullback. When the pull back is over, and it wasn't strong enough to destroy the premise of a favorable trend, I will re-enter with the correct stop. I only re-enter like this if I also took the setup that started the trend (not logical but I like to have a profit before using that possibly wide stop). There is really no reason to scale out if there is a favorable trend. You could instead look to exit once it becomes weak, protracted, climactic etc. at some S/R level. That will provide significant risk/reward trades and off set many small losers.
If a trend is protracted, I will be looking to exit at some S/R level. I don't want to hold through dozens of bars of TR price action. I don't scale out anymore but instead exit and re-enter when I am worried about a possible deep pullback. When the pull back is over, and it wasn't strong enough to destroy the premise of a favorable trend, I will re-enter with the correct stop. I only re-enter like this if I also took the setup that started the trend (not logical but I like to have a profit before using that possibly wide stop). There is really no reason to scale out if there is a favorable trend. You could instead look to exit once it becomes weak, protracted, climactic etc. at some S/R level. That will provide significant risk/reward trades and off set many small losers.
Thanks again Andreas for your detailed explanation, it was great insight and I will most likely sit on this idea for a bit and possibly do the same after some minor adjustments for this method to match my trading style
