The right place to set a stop and initial profit target in a forex trading system is often subject to a couple of factors. The first factor is what the system itself will tolerate, and the second is your personal tolerance for risk. Just because a system looks like it will be profitable does not mean that you want to trade it. If the stop loss potential is more than you can tolerate, or the trading frequency is too high, the system may disqualify itself from consideration, simply because it doesn't meet your trading tolerances. The good news is, there are enough strategies and systems out there that all traders can find one that fits their needs.

Developing a stop and limit order, or profit target in a forex trading system can be tricky. The risk for over optimization is very high. However, there are a few things you can do to identify whether that has happened. As we develop a stop and profit target in this section we will be referring to the system rules that were developed in the first building forex systems lesson.

We have found that developing stops and profit targets can be explained as a three part process. The first part is is setting profit targets second setting the stop, and the third involves testing the system for validity. We will discuss the third component in the next lesson

1. Estimating profit targets based on historical results following a successful signal.
2. Establishing a stop loss that allows for normal volatility but protects capital.
3. Testing the system for performance and the dangers of over optimization

Estimating an initial profit target.
When trading a more mechanical system, such as the one we will follow here, it is a good idea to have an estimate of how far you think the market may move during a typical successful trade. In the chart below you can see a segment in time on the EUR/USD. The entry signals are shown as green arrows. An entry signal in this system is triggered when the CCI crosses above the -100 level while the COT report indicates that investors are net long the currency pair itself. Over the periods I tested on this pair, the market was moving an average of close to 700 pips when the breakout went the direction I had forecasted. To be somewhat more conservative, I will test a target 10-15% less than that average move. ....continued