Should You Stop Trading When Your Weekly or Daily Profit Goal Is Reached?

By Lawrence

imageMany traders choose to stop trading once a dollar based profit goal is reached. It is a safe guard against oneself from over trading. It also helps a trader from getting to aggressive due to emotional high triggered by reaching the profit goal too quickly. So is it a good idea to do this? I will explain how to do this properly in this article.

Your Income Goal for the Year Is Just An Estimate

In a complete trading business plan, we often define a profit goal for the year. It is a good practice doing so because it gives you the ability to track your progress and allow you to look at your own performance objectively. It is usually defined by estimating the expectancy from a combination of the trading setups you use, the frequency of each setups and the profitability of each setup.

In other words, it is an educated guess that if you can execute your trades perfectly and that the number of trades for each trading setups you use are happening near the average frequencies, you can pretty much tell the expected results by the end of the year. The calculations of expectancy is pretty simple. Links at the end of the article will point you to the articles I wrote on money management in case you need some help on the math needed.

The catch with this expectation, of course, is that it is rare things will happen exactly at the average. Number of occurrences for every trading setup varies all the time. The profitability of a trading setup also depends on the volatility of the market which changes from year to year. In other words, income or profit goal for the year, let alone monthly or weekly goals, are just educated guess with huge variance from one period to another.

Taking Advantage of Your Own Profitability Distribution

If your trading performance is very consistent and is not affected much by the volatility of the market you trade, you have a stable profitability distribution profile. It is safe to say that if your profit reaches one standard deviation above your estimated weekly profit expectation, you are not likely to do much better. Hence it is reasonable to stop trading, say, on Wednesday when you reached the profitability threshold, and do something else instead.

Similar argument can be made on daily trading results but we have to be cautious about the overall behaviour of our trading styles. For example, if you trade breakout setups, it is often the case that majority of the profit are generated at the last hour of trading. It is not a good idea to cut short your trading profit this way.

Once you impose upside boundary to your trading results over a week or a day, you have to impose the downside boundary as well. Otherwise, your profit distribution will have the potential of a very fat tail to the losing end. It is the price you have to pay for manipulating the other end of the distribution.

The title question can now be answered clearly. It is not a good idea to stop trading at your profit goal for the week if it is your average expected performance. Stop trading at one to two deviation above your expected performance is reasonable as long as your trading plan also include rules to stop trading at similar level of accumulated losses.

There are more factors to consider though as markets are not static in nature.

Embracing Uncertainties

If your trading style is developing, or that you do not know your profitability distribution, putting a profit goal and the corresponding loss limit on weekly or daily basis may help you preserve your trading capital better until you are more proficient with trading. This point of view is that a beginner trader is likely no better than 50/50 with their trading results, thus it is better to control the near coin flip performance with straight money management.

The problem with this approach, however, is that it cuts short the learning experience of the beginner trader. One of the most important lessons to learn for a beginner trader is to embrace uncertainties. Cutting short the trading duration either from reaching the profit goal or the loss limit means the trader does not get to learn to trade the rest of the market hours which may not have the same behaviour. For example, on daily basis, the afternoon hours for all the major markets are not the same as the opening hours. It is also true that many markets on Thursday and Friday have subtle differences in their price actions comparing to Monday and Tuesday within the same week.

Hence it is better for beginner traders to stay on simulation trading to figure out their trading style first, or looking into the historical trading results to see if there is a reasonable distribution of trading performance in the past, before considering to impose profit goal and loss limit. In other words, it should be about the maturity of your trading skills and how you like to design your trading business instead of the need of such rules.

A good reason for not using profit goal is the ever changing volatility of a market. It could be the case that you get to make $1000 a week per contract being one deviation above your expectation. But in a high volatility environment the amount that really represents the true profit potential can be $3000 a week per contract. If you cut short your trading week or trading day when you reach $1000 profit or loss, I am sure you are giving the random nature of the market to play dice on you.

If your trading method embraces volatility with stops and profit targets, meaning that at least partially they are based on the volatility of the market, you have to take that into account when you choose to use profit goal and loss limit with your trading.

Keeping Our Emotions in Check

An alternative solution to deal with high volatility environment is to stop trading all together so that you do not need to deal with the additional burden of emotional rides that you know you are not ready for. It is no shame to stay on the sideline when you know that a market is moving too fast on you. Remember that as a trader our goal is to extract profit from the market when the situation is in your favour. Anything that reduces your chance of staying profitable is a factor you want to eliminate.

One sign that you should stay away from a market is that the price actions is making you feel uneasy with raised rate of heartbeats. Another sign you should stay away is that you feel fear when you try to put a position on.  When you are ready for the more volatile trading environment as your trading experience increases and that your confidence has improved, you will no longer have these negative emotions affecting you.

Summary

Depending on your own situation and trading experience, setting a weekly or daily profit goal can be useful but you have to be aware of the potential pitfalls. I have covered some basics here on what to consider when one chooses to use profit goal with their trading. It is all part of your comprehensive business plan hence the considerations should be based on your overall approach to the market, not just whether you want such a rule in place to make you feel more secure or satisfy certain emotional need.

Resources

For more coverage on money management in trading, refer to my series Defensive Money Management Explained

Psychology plays a big role in how we approach trading, take a look at the books I recommend. Those ones on psychology can help beginner traders a lot in speeding up the learning process.

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