Let’s take a look at the chart below to get a better idea of how a trader would prepare for a trade. Note:There isn’t the time or space in this article to get into specific patterns. We’ll save that for next time! This chart is simply to show the process a trader would go through.
Although there are actually 2 technical patterns on this chart, we’ll focus on the ‘Breakout’ play that triggers at $15.20. As you can see from the chart, everything has been predetermined BEFORE the trade was taken. The entry is clearly $15.20, the stop loss (if we’re wrong) is $15.00 and we’ve decided on a 2:1 reward to risk ratio, so the target is $15.60. Only 2 things can happen. It will either pay us $400 if we’re right or we’ll lose $200 if we’re wrong. Thus, how often do I need to be right to make money? Less than 50% of the time.
There can be some subjectivity with regard to target areas, however, for me personally I always use 2:1 as my target. Through the years I’ve found it to be a very good balance in most market environments. The topic of ‘targets’ is a whole different discussion, one we don’t have time for today, but certainly of great importance. With regard to choosing targets, the most important part is that you are CONSISTENT. I always shoot for 2:1, and never deviate from that. If you stay consistent, the odds will work in your favor. This doesn’t mean that you have to shoot for 2:1 targets, and it also doesn’t mean that you can’t have different levels of reward to risk sometimes, based on certain charts and market environments. However, for most traders, especially newer ones, shooting for 2:1 targets is generally the way to go. If we don’t hit target, then we will stop out. It’s very straight forward and simple, unlike a long-term investor trying to figure out his or her target and stop location.
