The Moving Target Strategy (Backtest)
Last Updated on April 18, 2023
Many traders only care about their entry strategies and don’t bother about their exit methods. One thing they failed to realize is that getting out of the trade is probably more important than getting into a trade. Even those who plan their profit targets often use fixed profit targets. But the moving target strategy may present a better exit option. Wondering what the moving target strategy is?
The moving target trading strategy is a method of profit-taking whereby the trader allows the trade to run until the price shows a defined sign of a possible reversal. Here, the profit target is not based on a specific price level; rather, it uses an opposing trade signal to know when to exit a profitable position. The opposing trade signal can be based on pure price action or the movement of an indicator.
In this post, we answer some questions about the moving target strategy. We end the article with a backtest.
What is a moving target in trading?
In trading, target, or profit target, refers to the level a trader wants to exit a trade with profit. While most traders don’t put a lot of thinking into their profit target, the profit-taking strategy is as important as, or even more important than, the entry method.
This is why professional traders place more weight and attention on the exit strategy than their entry strategy. One method smart money use for their profit targets is the use of a moving target. In trading, moving target refers to the concept of having your profit target move as the price moves in your favor. That is, the profit target is not set at a particular price level, but rather, let to move with the price.
In essence, it is more like a trailing stop in the sense that it moves with the price. But it is not a trailing stop because there is no stop loss order that follows the price movement. Rather, the profit-taking strategy has to be based on a signal that indicates potential price reversal. When such a reversal signal appears, the trade is closed either automatically or manually.
What is the moving target trading strategy?
The moving target trading strategy is a method of profit-taking whereby the trader allows the trade to run until the price shows a defined sign of a possible reversal. In other words, the profit target is not based on a specific price level, rather it uses an opposing trade signal to know when to exit a profitable position. The opposing trade signal can be based on pure price action or the movement of an indicator.
For example, your moving target exit strategy could be to close your position when the price makes a 10-day low. It could also be when a fast moving average indicator crosses the slower one. Note that the signal doesn’t necessarily have to be related to the one used to enter the position. You can enter a trade with a breakout strategy and use a moving average crossover to exit.
How does the moving target trading strategy compare to other trading strategies?
The moving target strategy compares favorably to other trading strategies if the market is trending. In such a situation, you would want to ride the trend and milk the profit, so the moving target approach allows you to do that.
It functions like the trailing stop method, but it is not the same thing. In the moving target approach, exit is based on a potential sign of a trend reversal, such as the price breaking out of a 10-day low or a fast moving average indicator crossing over a slower one.
What are the key components of this strategy?
The key components of the moving target strategy are as follows:
- A trending market: The market should be trending so as to offer the potential for more profits to be made by living the trade to run, rather than having a fixed profit target.
- An entry method: You will need an entry method to get into the trade in the direction of the trend. Your entry method can be a breakout method, a momentum strategy, or any other technique that gets you into a trend-following trade.
- The exit strategy: You will develop an exit technique that gets you out of the trade when the trend shows signs of reversing. This can be the exact opposite signal to the one that got you into the trade or a different signal. Common examples include a 10-day low and moving average crossover.
How can backtesting be used to validate the effectiveness of the moving target trading strategy?
You can backtest the moving target trading strategy by coding your preferred exit technique and testing it out on historical price data. The first step is to know the signal you will like to use to get out of a position — say a 10-day low breakout, a moving average crossover, a long-period stochastic oversold/overbought signal, an MACD signal, etc.
Whatever method you prefer, create the code as a trade management bot and backtest it with your various entry strategies using past price data. You can even combine the codes into one bot and backtest. The idea is to combine the moving target exit with your other exit methods to know the one that offers the best profit potential for each entry method.
What are the potential risks associated with this strategy?
The main risk associated with this method is giving back some of your profits before the exit signal occurs. In a fast moving market (high volatility), one price bar can erode all your profits and even take you back to a losing situation while the exit signal has not been generated. This is why it is preferable to use a price action method, like the 10-day low, rather than an indicator method. With a price action exit, your trade is closed once the price has crossed the 20-day low.
What kind of data should be used to develop a moving target trading strategy?
The best data for a moving target trading strategy is price data. Indicator-based data may work, but they may not respond quickly to changing market conditions as the price data would. So, it is best to create a moving target strategy that is based on price action.
You can use any price data technique: it could be a certain period breakout or a candlestick signal. For example, in a long position, a shooting star candlestick on a higher timeframe could be a signal to get out of the trade. However, the 10-day low is a common method for a long position, and the 10-day high is a common method to exit a short position.
What types of assets can the moving target trading strategy be applied to?
The moving target strategy can be used to trade any asset type. It can work with stocks, indices, Forex, commodities, futures, ETFs, and even cryptocurrencies. What matters is to backtest whatever method you develop to be sure it works on the market you want to trade.
For instance, a 10-day low or high may give back a lot of profit when trading stocks. If your backtesting indicates that, you can tweak your parameters to say 5-day low or high. In a different market, you may find that it is a 12-day low/high that works best or even a different exit criterion, such as reversal candlestick patterns.
What are the most important parameters for a successful moving target trading strategy?
The most important parameter for creating a successful moving target strategy is the potential for a price reversal. With a moving target strategy, your aim is to stay in the market and milk the trend for as long as possible until there is an indication that the trend is about to reverse.
So, the criteria you use to define a potential trend reversal would be the most important parameter in your system. This could be price behavior or an indicator signal. You may have to do a lot of backtesting and tweaking to arrive at the best parameters that give you the best chances of making the most profit.
How often should the target price of the strategy be adjusted?
Although the name of the strategy makes one think you need to keep adjusting your profit target, that is not what the strategy is about. With this strategy, you don’t have a fixed-level profit target, so there is nothing to adjust.
The strategy is all about allowing your profit to run until you there is a clear indication that the trend has run out of momentum and may be about to reverse. If your strategy is automated, at the point the potential reversal signal is given, your trade is closed automatically, but if you run a manual system, you will have to watch out for the exit signal and close your trade when it appears.
What types of indicators should be used to identify potential entry and exit points?
Most technical indicators can be used to create entry and exit strategies. It all depends on your preference, the market you want to trade, and the way you want to trade. If you prefer a trend-following strategy, you may want to use trend indicators like moving averages, ADX, and so on.
For a momentum strategy, you may want to consider MACD, OSMA, and moving average crossovers. If you want to trade a mean-reversion strategy, oscillators like the RSI and stochastic are your best bet. No one indicator is the best: what works is how you use them. Whatever entry or exit strategy you create, make sure you backtest it to be sure it works.
What are the best practices for managing position size when using the moving target strategy?
The best practice for position sizing is to risk only 1% of your account balance in any trade. However, when riding the trend with a moving target strategy, you may be tempted to add to the profitable position and make more money. While this can be a good strategy, you need to be careful not to overdo it.
If you are adding to a winning position, make sure you define the risk based on the floating profit and have a price level where you close all positions to avoid turning a winning position into a loss. Also, you must have a maximum position size you cannot exceed.
What are the benefits of using a moving target trading strategy?
There are many benefits of using a moving target strategy. These are some of them:
- You can potentially make more profits, as you let your profits run and ride the trend to its logical conclusion.
- Letting your profit run also helps you to develop your trading psychology and mental skills — the ability to not focus on the profits but rather on the exit signal.
- You can add on to a winning trade and make more money — that is, you use the floating profit to carry more trades that can potentially make more profits.
How can the performance of this strategy be improved with backtesting?
You can improve performance by testing different parameters and criteria for exiting a position. For one entry method, you can test many different exit methods, and in the end, you choose the one that makes the most profits.
For example, the entry method may be a breakout strategy. For this entry method, you can use backtesting to check whether a 10-day high/low breakout, a reversal candlestick pattern, or a moving average crossover that offers the best profitability.
What are the key steps involved in creating a profitable backtested moving target trading strategy?
Here are the major steps for creating a profitable and backtested moving target strategy:
- Finding a tradable idea: This can come from brainstorming or interacting with other traders.
- Defining parameters: You define the parameters of the idea to convert it to a tradable strategy
- Developing the strategy: You create the strategy and write the code.
- Backtesting: You test the strategy on historical data to see how it performs.
- Tweaking parameters and validating: This is known as optimization. You would have to keep some out-of-sample data for this validation process.
The moving target strategy backtest
A complete backtest of a strategy with strict trading rules and settings is coming shortly.