One of the most challenging aspects of trading is setting a realistic and probable profit target. In fact, most traders that I’ve talked to over the years would put taking profits above entry strategies in terms of where they struggle the most.
It is true that knowing where to take profits can be harder than finding favorable entries, but it doesn’t have to be. By using something called a measured objective, we can determine a realistic profit target for a myriad of price action patterns.
In this lesson, we’re going to take a look at how to use measured objectives to find profit targets that are both realistic and probable.
More specifically, we will discuss how to calculate the measured objective for four common price action patterns. Those patterns include the double top, head and shoulders, equidistant channel and wedge pattern.
Let’s start by defining what a measured objective is and what it can tell us about future price action.
What is a Measured Objective?
Every price action pattern has a role to play. Whether it’s a topping pattern, bottoming pattern or continuation pattern, each one represents a critical piece of the puzzle when evaluating a market’s behavior.
These patterns not only give us insight into a possible trend change or continuation, they also allow us to gain an edge when assessing the extent to which a market is likely to move as a result of such patterns. These moves are referred to as “measured moves”, which is the distance measured from the break of the pattern to the measured objective.
The image below illustrates the difference between the measured move and measured objective.
Notice in the illustration above, the measured move is the same distance as the move leading into the channel. Therefore the measured objective becomes our profit target once price breaks channel support.
Now that we’ve defined the difference between a measured objective and a measured move, let’s take a look at how to calculate profit targets for four common price action patterns.
Double Top Pattern
The double top pattern is a topping pattern which typically forms after an extended move up. As the name implies, it forms after the market fails on a second attempt to make a higher high.
To find the measured objective, we simply need to measure the distance in pips from the high of the pattern to the neckline and then extend that same distance from the neckline to a lower level in the market.
The illustration below shows how to calculate the measured objective for a double top pattern.
Note how the distance from the neckline to the resistance level that formed the double top is 400 pips. We then measure 400 pips below the neckline to find the measured objective.
In the event one of the highs that formed the double top is higher than the other, you should use the distance from the lower high.
This will keep your measurement conservative, which helps to avoid setting a profit target that may be too ambitious.
Head and Shoulders Pattern
The next pattern on our list, which is also a reversal pattern, is the head and shoulders. Like the double top, this pattern occurs after an extended move up and signals a possible reversal in the market.
To find the measured objective for a head and shoulders pattern, we need to measure the distance in pips from the head to the neckline and then extend that same distance from the neckline to a lower level in the market.
This pattern is a bit different from the double top in that the neckline isn’t always a horizontal level. In fact, the neckline is most often represented by a diagonal level, such as the one in the illustration below. This means that we have to take into account the level at which price breaks down from the pattern when calculating the measured objective.
The image below illustrates how to calculate the measured objective for a head and shoulders pattern.
Take note that the measurement from the head to the neckline occurs at a different area than that of the measurement to find the objective. There is some overlap between the two as the neckline is not a horizontal level. This is important to keep in mind as it will affect the placement of your profit target.
To be continued