Investors have different methods of deciding when to enter and exit a trade. Those who prefer technical analysis over fundamentals use a variety of technical charts, looking for patterns such as ascending triangles, head and shoulders and double bottoms. These have rapidly grown in popularity among individual investors, but the biggest challenge when using these patterns is deciding when to exit an existing position.
Most traders understand the need for an exit strategy when a trade goes against them, but fewer have a plan for winning trades. Experienced traders are in the habit of developing a profit exit, the price point at which they close their position and pocket their gains. The key is choosing the correct approach to setting a closing price and sticking to it.
Many different targets can be used when using technical chart patterns, but most are based on the concept of support and resistance. While there's no sure way to predict future resistance, chart patterns give you a good starting point for establishing a price target. One of the most popular methods involves measuring the height of the pattern and then either adding it to or subtracting it from the breakout price.
Let's look at this chart as an example: a trader who is able to identify this ascending triangle will set his or her target near $25. This target price of $25 is calculated by taking the height of the pattern of $2.60 ($22.40 - $19.80) and adding it to the entry price of $22.40.
You can also use the height of the pattern to calculate the target on patterns that predict a downward trend, such as a head and shoulders pattern. The only difference is that the height is subtracted from the entry price rather than added to it.
Many conservative investors use the height of the pattern to calculate their maximum target, but often choose to close out their position earlier, ensuring that they lock in their profits.
Risk management is an essential skill for any trader and setting a stop-loss target is one of the first disciplines experienced traders master. But consistently setting a profit exit is just as important, and chart patterns are useful tools to help you develop a successful trading strategy. (See also: Price Patterns - Part 1 and Technical Analysis.)