When trading forex, setting profit targets using technical analysis can be relatively straightforward. For example, a profit target for a head-and-shoulders pattern would be measured according to the height of the pattern from the top of the head to the neckline. Similarly, a rectangle consolidation would be targeted after breakout according to the height of the trading range. Other ways to set a target would be to use prior support/resistance levels, pivot points, or Fibonacci extensions. And yet another way would be to set it according to a desired risk:reward ratio.
Although all of these methods are very neat and clean ways to determine specific profit targets, price often fails to do what we would like it to do. Trying to pinpoint a precise profit target is usually a hit-or-miss affair, especially in the roller coaster ride that is currency trading. One of the worst possible scenarios for traders is when price just misses a profit limit by a hair, and then reverses on a dime, ultimately to turn a substantial profit into a loss. Another frustrating scenario occurs when a profit target gets hit and the limit order gets executed, and then price subsequently proceeds to move well beyond that level.
Therefore, setting concrete profit targets with the use of limit orders is generally an arbitrary act. In most cases, it is better to let the market actually tell you how much it is willing to give you. The natural way to do this is through the use of trailing stops. There are two primary types of trailing stop-losses – automated and manual. Automated trailing stops follow the market by a pre-determined number of pips. This can also be somewhat arbitrary, as the trader must somehow choose the optimal number of pips upon which to base the trail. Manual trailing stops, on the other hand, where the stop loss is moved manually by the trader according to specific market price action, is perhaps one of the better ways to deal with profit situations.
Trailing stop-losses epitomize the concept of letting profits run and cutting losses short. Theoretically, a well-placed trailing stop can allow a profitable position to extend on forever as long as price continues to trend in one direction. Of course, a trend that never ends is only a dream. But if that dream ever came true, the traders with the trailing stop-losses would undoubtedly be happiest.
If executed properly, trailing stops can work extremely well for forex traders, especially for medium- and long-term trades. The most common practice for manually trailing stops is to place the trailing stop right below the last swing low, or pullback (dip), in an uptrend. The opposite is true in a downtrend. Automated trailing stops follow price by a set number of pips, so they can either be an exercise in arbitrary decision-making or they can be based on some less random method like the recent average true range (ATR). In any event, manually-trailed stops are generally more logical and more based upon actual market conditions than the automated variety.
A related practice to trailing a stop-loss is setting the stop-loss to break-even once a trade goes into initial profit. This is often an excellent technique to use for faster-moving markets. If the trade continues in profit, the stop-loss can then be trailed further in order to lock-in additional profit. A common practice in forex trading involves opening multiple fractional positions. When an initial profit level is reached, profits are taken on the first of those positions, while the stop-losses on the remaining positions are reset to break-even. In this manner, profits can be run indefinitely, but only if the market is willing to give those profits.
However they are used, trailing stops are often considered to be more logical, more usable, and generally of a higher probability as a trade exit strategy than setting arbitrary profit targets, especially for medium or longer-term forex traders.