In the world of trading, it's easy to get caught up in hindsight analysis, where it becomes tempting to draw conclusions about when one should have taken profits - Hindsight is always 20/20. Relying solely on specific, rare situations for profit-taking guidance can lead to limited future success. As traders, it is crucial to base our decisions on a large sample size of data and consistent behavioral patterns in the assets and products we trade. This article aims to shed light on the importance of realistic profit-taking expectations, the pitfalls of greed and fear, and the challenges posed by revenge trading.

Realistic versus Unrealistic Profit-Taking Expectations

Beginner traders often grapple with the question, "Where should I take my profits?" This inquiry stems from their lack of experience and insufficient time spent studying data, collecting relevant information, and making mistakes while actively participating in the market. It is natural for novices to seek guidance on this matter, but traders who have been trading a particular setup for an extended period should have already acquired the necessary knowledge. Forward testing setups, collecting data (through trade documentation), and constructing a trading playbook should be the foundation for determining take-profit (TP) targets. While price action, tape reading, and bid/ask stacks can provide additional guidance, they should complement and not overshadow the insights derived from charts.

Greed: The Temptation of Quick Gains

Greed often drives traders who seek to make quick profits with minimal effort. Unfortunately, such an approach undermines the necessary time and effort required to study setups and improve trading skills. Trading is not an industry that consistently allows for rapid gains. While luck may result in a single profitable trade, replicating that success and creating true consistency without investing in a trading education or proper setup analysis is unrealistic. Greed can also manifest after consecutive losses, leading traders to pursue a single winning trade to cover their losses. However, these expectations are often unrealistic and give rise to another destructive trading behavior: revenge trading. Traders will only stop feeling greed when they have fully internalized that trading is a long game. The market quickly weeds out those that are looking to get rich quickly.

Fear: The Dangers of Premature Profit-Taking

On the opposite end of the spectrum lies fear, which can be just as detrimental as greed. Exiting trades prematurely out of fear dilutes overall gains and leads to larger losses in the long run. Traders who lack experience with a particular setup may succumb to fear, becoming overly cautious or allowing past trades to influence their decision-making. While reducing position sizes in response to consistently poor performance is acceptable, trading under fear and consistently exiting trades to early hampers long-term success. It is essential to strike a balance between caution and maximizing gains. One of the best ways to find this balance is through your own trade review. Certain setups will always have an ideal profit-taking zone, but only through your own personal trade review will you find the balance that works best for your personality.

Determining Optimal Profit-Taking

So, how can traders determine if they are either too conservative in taking profits or overly greedy, letting profits erode? The answer lies in studying the patterns of their trades over a large sample size and analyzing actual trade executions. If this sounds familiar, you have probably read some of our other articles about the trading playbook and trade review. By comparing this data across hundreds of trades, traders can assess whether they have underperformed the overall optimal gains expected from their setups. It is important to remember that the goal is not to maximize every setup's profit potential but to achieve optimal profit-taking relative to the average behavior observed across a significant number of trades.

Revenge Trading: A Tempting Pitfall

Revenge trading often stems from feelings of injustice, such as being stopped out of a trade only for the price to move in the trader's favor soon after. It is behavior influenced by various factors, including greed and personal traits. Even experienced traders may struggle with revenge trading, though through my own experience and in working with higher-level clients it is something that eventually subsides. Revenge trading is trading from a compromised mental state. Naturally, this distorts profit targets, leading traders to extend take profit levels to recover losses from previous trades. Establishing strict discipline rules can help mitigate the risks associated with revenge trading.

Study and Collect Data

The first step towards developing effective profit-taking strategies is to collect a large sample size of data reflecting the patterns observed in traded setups. If you are unsure about what kinds of data to collect, read this article for starters. This data should be used to develop a system that informs profit targets or trailing-out decisions. A straightforward method involves assigning binary outcomes (yes or no) to variables indicating whether specific conditions were met during a trade. A trade should only be sold for very specific reasons - Legitimate reasons to sell the trade, not “I am up XYZ dollar amount.” Relevant variables to sell a trade might include factors like price hitting your pre-planned target, intraday trend breaking, VWAP breaking, the index being at an important technical level, breaking news, an unusual seller on the tape, etc.

Studying Trading Performance

The journey of studying and improving trading performance is an ongoing process. Traders must consistently compare their historical trades to their suggested profit-taking levels. Mistakes and underperformance are normal, and they should be treated as learning opportunities rather than deterrents. Finally, it is essential to remember that scaling out of positions in partial exits is more advantageous than waiting for a single perfect exit. Market conditions can change rapidly, and what was once a green trade can quickly turn into a break-even or even a loss.

Conclusion

Scaling profits in trading requires a disciplined approach that balances realistic profit-taking expectations with the pitfalls of greed, fear, and revenge trading. By basing decisions on a large sample size of data, studying trade patterns, and collecting relevant information, traders can develop effective profit-taking strategies. Remember, trading is a journey of continuous learning, and optimizing profit-taking relative to the average behavior of setups is a more achievable goal than seeking perfection in every trade. If you currently struggle with setting profit targets and want to learn using real-time market data, join us in the Trader’s Thinktank. We share a list of high-probability trade ideas with entry triggers and profit targets every day. A 14-day trial is available by clicking here.