The target Price Helps You Figure Out Your Risk-To-Reward Ratio
When you first form your plan for a trade, you should consider approximately what price or price range you think the stock is likely to reach. You can call this a target price, but this label gives some traders the wrong impression of its purpose.
A target price is not a price that the stock has to meet. A stock does not have to do anything, and certainly not just because you think it will or you want it to. If you treat your target price as a goal, it can lead to all sorts of trouble and false expectations.
Instead, your target price should be used simply as a planning tool. The target price helps you figure out your risk-to-reward ratio. It also gives you an exit point, or at least a point where you’ll reassess whether you believe the trade can continue to move upward. Your trade may never reach your target price, though. Other things can interfere with its progress. And there’s always the possibility that you set your target price higher than you should have.
Since there’s no way all your plays will hit your target price, it can be a good idea to make a habit of selling half your position at a more conservative target price. Routinely taking profits along the way will reward you in the long run.
There are a number of things that can interfere with the progress of a stock’s movement and force you to close your position sooner than you’d anticipated. What to do if any of these possibilities become realities should all be part of your plan. Along these lines, here are reasons you should always close a position, whether or not it has made it to the target price you thought it would:
• The end of a trend: You realize the trend isn’t working anymore.
Exiting a losing trade is not a big deal. Quite the contrary - it’s good trading. The best traders would rather lose a small profit than take an unnecessary risk. You don’t have to win on every trade; no one does, and it’s dangerous to try - it can lead to huge mistakes. In fact, by limiting losses, a good trader can be profitable overall by making money on only 40 percent of his trades.
• Broken momentum: The stock’s upward movement has slowed or been abruptly broken.
• An approaching major psychological barrier: The stock is about to reach $100 or $200 a share (you probably should have anticipated this as part of your plan.).
• An approaching technical barrier: The stock is about to reach a resistance level it’s been unable to break through before (again, you should have anticipated this as part of your plan.)
• Unsafe market conditions: A sudden marketwide decline, the threat of one, or serious uncertainty.
