How to Find High Reward Trades Based on Price Structures (Entry, Stop Loss, Profit Target)
Cory Mitchell, CMT
Most people spend a lot of time looking for the perfect entry. The entry is important, but equally important are the exit points (stop losses, trailing stop losses, or profit targets), and position sizing. All are key to success.
An exit strategy is often neglected. Most traders know how to place a stop loss, but knowing when to take a profit is one of the hardest things for most traders. Part of this is psychological as two conflicting interests tend to mess people up.
- The trader doesn't want a currently winning trade to turn into a loss.
- A trader doesn't want to take profit off the table too early and miss an even bigger move.
These two conflicting issues, if not handled, will typically result in the trader oscillating between the problems, or gettings stuck on one.
The trader may cut winners too early, fearing a loss. Or they may fail to take profit when they should, thinking they can get a bit more profit. Some traders flip-flip between the problems.
In this article, I will discuss the profit target exit. I discuss stop losses here, and a couple of versions of the trailing stop loss in the stop loss article, the Renko article, and the one-bar article.
Profit Targets Based on Price Structures
A profit target is a pre-defined exit point where we take profit on a trade.
The profit target is set before the trade, and is based on a price structure the price has been moving in.
The profit target doesn't change once it is placed, unless the trade meets one of the exceptions discussed below.
A profit target doesn't change because before a trade we are more rational and objective than we are during a trade. Once that trade is placed, the two psychological problems mentioned above begin to mess with our heads. When we don't have a trade, those two issues aren't "real" yet. Once in a trade, we should be hesitant to trust ourselves. In the logical headspace before a trade, our objective analysis is more trustworthy. This is why we plan our trades before taking them, because then all we have to do is follow the rules we laid out.
A trailing stop works the same way. We only exit based on a method we determine prior to the trade.
Price structures are areas the price is moving between. The area may be trending, channeling (rising, falling, sideways), conversing (triangles), expanding, moving between high and low points (ranging). Chances are, on nearly any timeframe, you may see a few of these structures playing out.
Your job is to look at the price structures and determine how you want to trade it.
For swing trading, start with the daily chart and mark all the major highs and lows with horizontal lines. Then connect recent swing highs with swing highs and swing lows with lows. Look for triangles, channels (regression channels can be useful), expanding ranges. These do not need to align perfectly with a trendline! They are just meant to show how the price is "generally" moving.
Any pair near the extremes of one of these price structures presents a potential trading opportunity.
You will also want to determine what is important based on your time frame. If you take trades that last a few days, then only the current price structure may be important. Distant price structure edges don't matter right now. If the price moves quickly though, they may become important.
In the chart above, we have lots of price structures going on. The price has made a few major swing high points. These are marked because the price had strong reversals off those levels. We also note the price has been making lower swing lows.
The price is moving in a small triangle-like pattern right now.
Drawing the structures help me see where I will be trading and where I won't be. The current structure is tradable, if it presents an opportunity. If the price moves out of the triangle, my next trading opportunities come when the price gets close to the other levels drawn, OR a new price structure develops.
Once the price is near a price structure edge, drop down to lower time frames to look for entries and where to place a stop loss.
The profit target goes on the other side of the price structure. It's better to be conservative and have the target reached than be too aggressive and miss the exit. For example, if shorting at the top of a range, place the target just above the prior swing low, not at the exact prior low.
If there are no price structures, you either don't trade, or you don't use this profit target method.
It will take time and practice to see the price structures that are in play. You will likely miss a lot at the beginning. I still miss some. But once you start to see them, you could trade price structures and nothing else. If using various timeframes, and looking at a list of currency pairs, there are high reward price structures nearly every day. If only swing trading daily, 4-hour, or hourly charts, high-quality trades may not occur every day, but several per week are highly likely.
Combining Price Structures
As mentioned, sometimes you may have multiple price structures going on: one within another, within another.
You have a choice:
- Place a target based on the current price structure only.
- Place a target based on a larger price structure than the current one.
Option one is the easiest. "See a range, trade a range".
The second option requires looking at the bigger picture.
Assume there is a big range on the daily chart. The price is in the middle of that range forming a large triangle. You could buy or sell at the edges of that triangle, with a target on the other side (option 1).
You could also place a target near the larger range, assuming that it will eventually reach those edges again. I would only do this when a price structure occurs within a much larger strong trend (I call it "front running").
Option 2 is more useful for breakouts, when the price breaks out of one structure and starts heading toward the edge of the next structure.
Over time, if the price moves without touching price structure edges (line), then we may be able to draw some new lines/price structures based on more recent price action.
On the GBPUSD chart above, option 1 is trading the triangle as it is. Option 2 is useful if the price breaks out of the triangle, the other price structures may provide some insight into where the price will head next. Rember to be conservative with the targets.
Profit Target Timeframes
Base your structures on the daily chart (or at least a time frame or two higher than what you typically trade on). This provides your overall context.
When the price is near a price structure edge on the daily chart (or your "high" timeframe"), drop down to the hourly chart to see how the price is acting around that support or resistance level (price structure edge). You can then even drop to a 15- or 5-minute chart to find exact entry points.
Place your stop loss, as discussed in the stop loss article. If going short, put your stop loss just above the recent swing high. If going long, place the stop loss just below the prior swing low.
Your target is based on the price structure you are trading on the daily chart (or a time frame or two higher than what your entry is based on).
Using the daily chart for the profit target, and a smaller timeframe for the entry means a higher reward:risk trade than if everything was based on the daily chart. This is because you can typically find a much better entry point on the lower time frame.
Consider this AUDUSD example.
It is in a rising regression channel. The price has reached the bottom of the channel on the daily chart.
Since the price is near the bottom of our price structure, we can look for an entry on a lower time frame.
A consolidation breakout or a breakout of a small range near the structure edge is a method I commonly use to enter. Other price action signals in the small waves around the edge are beneficial.
I then place my profit target. For this pair, I am looking toward the top of the price structure. Remember to be conservative.
A profit target is placed below the prior swing high. The color-coded box shows the entry, stop loss, and target.
We can quickly see that our potential profit (green area) is much more than our risk (red area). This is required because we won't win all our trades...we may only win 30% or 40% of them. But if each winner has a great reward:risk, then we can still make good returns.
Consider losing 1% of your account on 7 losers, but winning 5% on 3 winners. Your account is still up 8% even though you lost 70% of your trades.
With practice, you may be able to win more than 30% or 40% of your trades, but you certainly don't need to.
This is Not a Crystal Ball
With a profit target we are assuming that the market will continue to do what it has been doing. For a time it may. Eventually, it won't. If it keeps doing what it is doing, we make a nice profit. And we may even make a nice profit if the price doesn't keep doing what it is doing. For example, in the trade above if the price surged higher, breaking above the channel. We still make money even though the price didn't stay in the channel.
I like this method because it based on what we know, right now. We don't need to try to forecast what the price is going to do in the distant future. We are trading a strategy, knowing that even if we are wrong a lot, with nice reward:risk trades a few winners will more than makeup for the losses.
It also forces us to consider scenarios. If the price moves to an edge of a triangle, it could move either direction. We don't know which, but if we wait for price action to tell us, then we can act without bias. We can enter on a breakout, or trade if the pattern continues. Either way, we have awaited price action to give us a signal, and we have the structures backing us up and providing profit targets.
Examples of Profit Targets Based on Price Structures
Once a price structure is recognized, it may provide several trades before the price moves into another structure.
The USDCAD formed a nice descending channel. The channel was large enough and pretty flat so it could be traded in both directions, near the edges.
It provided multiple nice trades before the price finally moved higher and into another structure.
This is a daily chart to show the overall structure. Actual trade levels would be based on the hourly or lower timeframe.
Not every one one of these trades may have worked out the first time. An entry may have been taken, and then stopped out. Then another entry is taken. The charts provide a guide for setting profit targets; note how all the targets (green box areas) end before reaching prior swing highs/lows.
The concept is applicable on all time frames. The USDCNH chart below is an hourly chart with a triangle. Entries could have been based on the 15- or 5-minute chart.
No need to make things complicated. Make money while the price action makes sense. Once it doesn't, or you don't recognize the price structure, don't trade.
A lot of people get so wrapped up in thinking about when a price structure will end, that they totally forget there are a lot of opportunities and money to be made while the price structure is forming.
If you aren't seeing any price structures you may need to practice more, or it may be a fast-moving market. When that is the case, reduce the time frame to see the structures. For example, when the USDCAD spiked higher on the daily chart above, it just shows upward bars. A smaller time frame would show channels, consolidations, etc.
When trading price structures, we wait for evidence that the price structure is continuing before entering! If we are going short at a resistance level (top of structure edge) we are waiting for the price to approach, touch, or even move slightly beyond the level. Then we are waiting for the price action to signal a reversal, indicating that the level has held and the price is likely heading lower again...toward our waiting profit target.
Once the price breaks out, it will form a new price structure. We can use bigger price structures to provide profit targets. If there are no relevant price structures that provide a profit target, consider using a trailing stop loss, or look at the size of recent price waves and structures for an idea of how far the price typically moves.
If the price breaks out and then comes back into the old price structure that is a false breakout. It is a highly tradable setup.
Final Word on Setting Profit Targets Based on Price Structures
For many, including myself, it is easier to place profit targets based on what we can see happening right now.
Drawing the price structures provides a framework for where the price is moving. It also provides a number of potential trades, since we can look for trades near those price structure edges.
Do this on any time frame. Start on a higher timeframe to isolate the structure, then drop down to a lower timeframe to pinpoint the entry.
This a strategy. It is not predication in that I expect to be right all the time. The goal is to take trades with a good reward:risk ratios (3:1 or higher, but I really like the 5:1+). I may only win 3 or 4 out of 10 trade with an average reward:risk of 4:1 or greater, sometimes even 10:1 or greater. Do the math...that works out to a good return.
We are getting those risk rewards based on a profit target that the price could easily reach...the price has already made similar moves recently.
This is far more useful than having a high reward:risk ratio, but the price has to do something extraordinary in order to reach the target. With the price structure method, nothing crazy has to happen to make a fantastic trade. And if something crazy does happen, that just means we get out of trade quicker (profit or loss) and can move onto another trade.
It is one method. Using it is not a requirement. Take from it what you will to create your own method of trading.
By Cory Mitchell, CMT @corymitc
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.