Profit Targets: Important or Bad Idea?

09/30/2013 6:00 am EST

Focus: TRADING

Frank Kollar of Fibtimer.com explores whether setting a specific profit goal is good practice or whether it only sets a trader up for failure.

Many traders and investors set goals. Typically, a goal might be to achieve a 12% gain every year. Although it is pretty obvious that the markets cannot be depended upon for a "steady" rate of return, the question is, is it even a good idea to set such goals?

Would you rather have a steady return of +12%, +12%, +12%, +12% over the next four years? Or an unpredictable rate of return with potential drawdowns, say, 0%, +50%, -5%, +40%.

Assuming the goal of 12% yearly is set for the next four years and you have an investment of $10,000 to start, +12%, +12%, +12%, +12% means in four years your investment would be worth $15,730.

But what about the unpredictable returns? 0%, +50%, -5%, +40% over four years will increase your original investment to $19,950, even though you spent the entire first year with no profits at all and lost money in the third year. That is a 27% greater a return overall.

There were long periods of time when you had no gains or suffered through losses, and you likely felt like those periods would never end.

These numbers are very realistic. Volatility can be your best friend.

Catch a Trend, Let It Ride!
Market timers using trend following strategies have no desire to try and reach, or to force results to meet, a preconceived profit target.

If, for example, we set a profit target of 12% and exited the 2009 rally to lock in that gain, we would have lost the full 55% gain realized.

Few saw the potential for such a gain in the stock market. But why exit a trend at 12% to guarantee a profit, and then sit on the sidelines watching the market go up another 50%, 60% or 70%?

In fact, we have no profit targets at Fibtimer. Our goal is to catch every tradable trend, and when we do, to let it run as far as we can before exiting that trade.

That means when there are no trends and volatile sideways trading, we will have no gains. But it also means that when the market does trend, and history shows that markets are in trends 80% of the time or better, that we will let our profits ride and take every bit of the gains we can as profits.

Trading Every Trend
There is no way to trade all trends without taking the risk that the current trend might be a false one. Risk management limits losses and protects capital, but at times small losses are inevitable in every profitable trading strategy.

By trading every trend, we are guaranteed that we will be on board for every money-making advance, and every money-making decline (bearish trades), that the future brings us.

But you must be around for the money-making trend, and you must have taken the trade, to realize the profits when we they occur.

Lessons of History
Remember the crushing losses of 2008-2009. The Nasdaq and the S&P 500 dropped over 50%. It will take a 100% gain for these indexes to again reach their late 2007 highs. In fact, the S&P 500 Index has not achieved a real gain in the last ten years period! Yet we have achieved profits in every one of the last ten years.

It is important that you approach timing with this in mind. If you give it a month and then quit because you have no gains, you are only fooling yourself. We will continue to make the profits over the years. Because we trade "all" trends, we "know" future profits will be realized. Years of experience and hundreds of years of market history are behind us.

Stay patient, follow the buy and sell signals, and the profits from the major trends are yours. Though we do try to look into the future in our weekly analysis, no matter what the markets bring us we trade the trends. That is the key to success.

By Frank Kollar, Editor, Fibtimer.com

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