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Do Profit Targets Add Value to a Strategy?
By: Arthur Hill | May 26, 2023

My research suggests that profit targets improve results for trend-momentum strategies that trade ETFs. Note that performance improvements may differ for other strategies. This article will first show a trend-momentum setup on the chart. I will then provide some performance metrics for a basic strategy with and without a profit target. TrendInvestorPro (here) introduced a similar strategy this month and the final part will be posted next week.

Trend-momentum strategies require two components: an indicator to identify the trend and an indicator to rank performance. I am using the Trend Composite to identify the trend and Normalized-ROC to rank performance. The Trend Composite aggregates signals in five trend-following indicators. Normalized-ROC is the 200-day point change divided by 20-day ATR. You can read more about these indicators here. The chart shows the Technology SPDR (XLK) with a positive Trend Composite and a Normalized-ROC(200,20) of 6.63, which is one of the highest ranked ETFs in our universe.



Strategies that trade stocks also require a market timing mechanism. In bull markets, the idea is to buy the ETFs that are in uptrends and that have the highest rank. Buy the strongest. A sell signal triggers when a bear market starts or the Trend Composite turns negative.

In the absence of a sell signal, traders can also consider setting a profit target and exiting when hit. For example, sell when the ETF is up 10%. I put this idea to the test with a universe of 74 stock-based ETFs that have trading history back to 2007. The test ran from January 2007 until April 2023, which is 16+ years. The strategy without a profit target showed a Compound Annual Return of 8.36% and an Average Drawdown of 16.79%. The strategy with a 10% profit target generated a Compound Annual Return of 9.6% and an Average Drawdown of 14.42%. The Compound Annual Return was over 1% higher and the Average Drawdown was over 2% lower. A profit target improved performance for this strategy.

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