One of the most difficult aspects of trading is setting a realistic and plausible target for your trade. In fact, most of the traders I have spoken to over the years have prioritized a profit collecting strategy over entry points for the most problematic items.
Granted, knowing where to profit can be more difficult than finding a favorable entry point, but it doesn’t have to be. By using what is known as a metric, we can define a realistic target for many price action patterns.
In this lesson, we’ll look at how to use timed motion to define a goal that is both realistic and probable.
Specifically, we’re going to cover how to calculate the movement measured for four common price action patterns. These include the double peak, head and shoulders, channel and wedge formation.
Instead, let’s start by defining what the target is, and also what it might tell us about future price action.
What is traffic measured?
Every price action pattern has a role to play. Whether it’s a top, continuation, or bottom pattern, each is a key piece of the puzzle when evaluating market behavior.
These patterns not only give us an insight into a potential trend change or continuation, but also give us an advantage in assessing the extent to which the market is likely to move as a result of such patterns. These movements are referred to as “measured”, which is the distance measured from the breakout to the measured target.
As the name suggests, a double top is a top formation that is usually formed after a long upward movement. It forms after the second, unsuccessful attempt to establish a higher peak.
To determine the measured target, we simply need to measure the distance in pips from the top of the pattern to the neckline, then pull the same length from the neckline down the market.
Notice that the distance from the neck line to the resistance level that was creating the double peak is 400 pips. We then measure those 400 pips below the neckline to find our measured target.
In case one of the peaks forming a double peak is higher than the other, you should use the distance from the lower peak. This allows you to be careful in your measurements, which in turn helps you avoid setting a gauged motion target, which may be overly ambitious.
Head with arms
The next reversal pattern on our list is head to shoulder . Like a double peak, it occurs after a long upward move and signals a potential reversal in the market.
To determine a target for a head to shoulder pattern, we need to measure the distance in pips from the head to the neck line, then drag the same distance from the neck line down the market.
This pattern differs slightly from the double peak in that the neckline is not always horizontal. In fact, the neckline is more often represented by a diagonal level as shown below. This means that when calculating the measured target, we must take into account the level at which the price breaks out of the pattern.
Take into account that the head-to-neck measurement takes place in a different area than the measurement to find the target. There is some overlap between the two because the neckline is not horizontal. Keep this in mind as it will affect the placement of the target for the transaction.
We will now move from reversal patterns to continuation patterns. Using a measured target in conjunction with a breakout from a parallel channel formation can be a very powerful combination.
Excluding the wedge pattern that we will discuss later in this article, the Parallel Channel is my favorite pattern for trading. This is partly because it is quite frequent and partly because the movement of traffic is more accurate.
The key to calculating the measured target for a parallel channel is to use all up or down motion as the measured motion. Note that the first and second down moves in the picture above are black. This black line represents 400 pips and partially overlaps the channel formation.
So remember to include all traffic to the channel as part of the measurement. The same goes for calculating the target on the other side of the formation.
Last but not least is wedge formation . This is my favorite trading pattern, as is the Parallel channel we just discussed. Wedge patterns are best played on a four hour or day time frame, and they come up quite often once you are trained, what to watch out for.
While they are most often seen as a continuation formation, wedges can also lead to a reversal. However, it doesn’t matter if the wedge is a continuation or a reversal pattern, as we don’t commit to a position until the market breaks support or resistance.
Finding the target measured for a wedge formation is possible after measuring the height of the formation in pips and projecting the same distance to the future point in the market.
Don’t forget about the key support and resistance levels
See also: 5 Traits of a Successful Investor
No objective measured is complete without being combined with a key support or resistance level. In fact, I often set a key level ahead of the target measured in determining the area where profits can be realized. This is because depending on the importance of this level, it will often “outweigh” the target measured for the likelihood of a reversal in the market.
So if the target measured for a pattern is 400 pips and the key level is only 350 pips away, it always targets the key level first. Better to be conservative and post 350 pips of profit than try to squeeze an extra 50 pips out of your trade and risk not earning anything.
The measured goals are not without flaws
As with everything else when it comes to trading, there are no guarantees and no strategy is without flaws. There is no exception to the case of using metered targets to define profit targets.
Although measured goals are usually quite accurate, there will be instances where these numbers will not match. It is for this reason that you should think of the objective being measured as the scale of possible market movement, rather than determining how the market will actually move.