Is it better to have a fixed profit and loss ratio, or a moving stop profit?
Fixed profit-loss ratio and trailing stop are the two most commonly used exit strategies in trading systems. Indeed, many people are torn between these two methods.
In fact, this issue is not complicated. I will use actual examples to thoroughly explain this issue to everyone. These two methods each have their strengths and weaknesses.
Let's first establish a trading logic. We will use the golden cross of moving averages and a break above the previous high as the entry condition, with a stop loss at the previous low. We will examine two scenarios separately.
The chart shows a 1-hour candlestick chart of spot gold, which is a very smooth bullish trend. The market entered after the low cross broke above 1829, and the market rose rapidly and significantly. In this trend, a fixed profit-loss ratio exit can only capture a small portion of the profit, while a trailing stop will hold onto a large space of profit.
In this trend, the trailing stop has an advantage.
The chart is also a 1-hour candlestick chart of spot gold, with the same entry condition, entering on a cross and a break above the high, with the stop loss set at the previous low.
The entry price is 1915, and the stop loss price is 1900, with a 15 USD stop loss space.
If this order uses a 2:1 profit-loss ratio, the order can exit at the high point of 1946, just 30 USD for profit, and then the market begins to reverse and fall.
If this order uses a trailing stop method, the profit will give back at least half during the pullback.
In this trend, the fixed profit-loss ratio has an advantage.These two profit-taking methods each have their advantages and disadvantages in different market trends.
When encountering a trending market, the trailing stop has an advantage as it can hold onto large profits; when encountering a wide-range volatile market, a fixed profit-loss ratio has an advantage as it can take profits in a timely manner and secure gains.
Let's delve deeper into the two different trading models.
The first image above, the trailing stop follows the trend, which is a trend-following trading model. This model aims to chase the trend as much as possible, hold onto large profits, and has a high profit-loss ratio.
Of course, since trending markets are rare and volatile markets are more common in all market movements, the trend-following model does not have a high success rate. In volatile markets, there are many small mistakes and consecutive errors, which can lead to losses. The profit-making model for all trend trades is to accumulate losses from small mistakes and make a profit from a big win.
The second image above, a fixed profit-loss ratio is a swing trading model. This model takes only a small portion of profit from each trade and closes positions quickly. Since volatile markets are more common in all market movements, a fixed profit-loss ratio can close positions in time during volatility and also close positions after taking a portion of profit in trending markets, thus having a higher success rate.
Each profit is not much, but the success rate is high, and small profits accumulate over time.
The purpose of our trading is to make money, there is no doubt about that. So, both of the above models can make money, but the process is different. All roads lead to Rome, it depends on which path you choose, and you should also make a choice based on your existing trading model.
So this is a multiple-choice question, not a true or false question. Since it is a multiple-choice question, different strokes for different folks, any choice is correct.
As long as the trading model you choose suits you, it is correct, and as long as the model you choose is profitable, it is correct. After organizing your trading system according to your chosen model and verifying its effectiveness through backtesting, just stick to executing it.Here's a little advice for making choices:
If you have a small amount of capital, it is recommended to choose a fixed profit and loss ratio to avoid too many consecutive losses and capital drawdowns.
If you have a more impatient personality, it is recommended to choose a fixed profit and loss ratio because you are likely to get anxious when you have consecutive losses, which can affect your mindset, and holding positions for too long when you are anxious can also lead to problems.
If you are a beginner in trading, it is recommended to choose a fixed profit and loss ratio for shorter profit cycles and easier execution.
If you are engaged in medium to short-term trading, choose a fixed profit and loss ratio.