Why a Two-to-One Profit Target Needs a Market Edge
Summary
The document examines whether setting a forex profit target twice as far from entry as the stop loss guarantees profitability. It explains that a favorable payoff ratio alone is insufficient: without a market edge, trades reaching the farther target would be less frequent, offsetting the larger gain on winners on average. Commissions and other trading frictions would make the expected result negative. The response relates this intuition to gambler's ruin, but gives no derivation or empirical test of the claim.
Whether letting winners run while cutting losses quickly is sensible depends on price behavior. Short-term momentum could support holding winning positions longer, whereas short-term mean reversion could favor taking profits sooner and allowing losing positions time to recover. If returns are close to random, the stop and target distances alone do not create an edge. These are conditional principles, not a complete trading system: the document does not specify how to identify market regimes, estimate win probabilities, or account for execution and changing risk.
Key ideas
- A larger profit target does not by itself make a strategy profitable.
- Without a market edge, the wider target is expected to be reached less often, offsetting its larger payoff.
- Short-term momentum may support cutting losses and holding winners longer.
- Short-term mean reversion may favor quicker profit taking, but the document provides no tested rule for choosing a regime.
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# Is forex trade set up where profit target is twice as far from stop loss is good strategy? # Is forex trade set up where profit target is twice as far from stop loss is good strategy? I was listening to this youtube video and the author is explaining that good way is to set up forex trades in a way where 10 pips in 'losing' direction (Stop loss) and 20 pips in 'winning' direction (Profit Target) and then getting 50/50 win-loss you will come out on top since you gain more by winning and lose less by loosing. However, to me, it feels counterintuitive IMHO to get x2 pips in wining direction is x2 as hard... so a ratio of win/lose in current setup would end up 33 wins / 67 losses... I must be missing something here. Is forex trading where winning pips are twice as far from the cut of is a good strategy? ## Answer by Chris Taylor (score 5, accepted) https://quant.stackexchange.com/a/41994 If you have no edge, then you would indeed expect twice as many losing trades as winning trades, so you would net out to zero return on average (negative after commissions and trading frictions). This is a special case of the mathematical result known as the gambler’s ruin problem. If markets are not random, but exhibit either short-term momentum or short-term reversion, then the advice is different. The advice to set profit stops twice as far from the entry as stop losses is a form of “cut your losses short and let your winners run on”, or more succinctly “the trend is your friend”. If markets exhibit short-term momentum then past winners are more likely to continue winning and past losers are likely to continue losing. In this case, it makes sense to hang on to winners and cut losers quickly. On the other hand, if markets exhibit short-term reversion then the reverse is true - you should take profits quickly and hold on to your losers, waiting for them to come back. So whether you follow this advice should depend on whether you think markets have short-term momentum, short term reversion, or whether you think they are close to random walks (in which case you should not trade). A more practical piece of advice is - the author of this video is wrong and you should not listen to them. Probably, you should not day trade forex at all. Most day traders lose money.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.