Can Partial Profit Taking Benefit Trend Followers?

Aug 5, 2021

Partial profit taking is a dilemma often faced by long-term trend followers. Could this benefit your overall strategy performance?

Let’s test!

You’ve probably heard the saying ‘Nobody ever got hurt taking a profit.’

In partial profit taking, you close out a portion of your floating profits, while giving your remaining lots the opportunity to accrue additional profits.

This certainly feels good, but does this actually benefit your long-term performance? Should you just let the full position run its course instead?

Before doing the tests, let’s discuss why partial profits are more relevant to trend following strategies.

Not All Strategies Are Equal

Short-term mean reversion traders are usually spared the dilemma of partial profit taking. Such strategies aim to capture a small price move, and usually have tight profit targets in place.

The chart below shows the distribution of profits/losses for a mean reversion strategy, which uses a small pip-based profit target.

Since the winning trades are small and consistent, there is little incentive to take partial profits.

Long-term trend following strategies are different, however.

These strategies rely on a small number of outsized wins to compensate for their low win rate. The distribution below shows the trade distribution for a trend following strategy with a 45% win rate.

Losing some of the outsized wins could significantly affect the strategy’s bottom line.

How Partial Profit Taking Affects Trend Following Performance

For the remainder of this post, I’ll use a Bollinger Bands trend following strategy containing a standard deviation trailing stop.

Here is its 16-year baseline performance (without partial profit taking) using a fixed 0.1 lots per trade:

The 804 trades have the following distribution, with the average trade being 22 pips. Notice the ‘fat tail’ on the right of the distribution that is crucial for the strategy’s profitability.

Your partial profit target should be large enough to allow you to ride the trend, whilst being small enough to capture sufficient trades. From the distribution above, the 250 to 500-pip region seems like a good compromise.

For this strategy, suppose you decide to close half your position (0.05 lots) whenever you hit a 100-pip floating profit. You then let the trailing stop take out the remaining 0.05 lots.

Here’s how that looks like in MT4:

Let’s investigate how different profit taking levels affect overall strategy performance.

Profit Target Optimization

I optimized the partial profit taking level from 20 to 1000 pips, in steps of 10 pips.

In general, there is a marginal improvement in risk-adjusted performance with partial profit taking.

Optimal return/maximum drawdown is achieved when the 50% partial profit is taken at about 450 pips. 10% of the original 804 trades hit this target level.

There is practically no improvement at very large profit targets since very few trades accrue this much floating profit.

I did an equity curve comparison using QuantAnalyzer:

The equity curve with partial profit taking is very similar because the trade sequence is preserved. The strategy’s improved performance is due to the better profit retention.

Your optimal profit taking level, or whether taking partial profits is beneficial at all, will depend on your strategy and market. If your strategy holds trades for long periods, or you trade a volatile market with frequent trend reversals, partial profit taking will make more sense.

Wrapping Up

Partial profit taking can be a viable option, especially if you’re a long-term trend follower.

As usual, do your backtests and let the results speak for themselves. Don’t do it simply because it’s psychologically satisfying.

If you do wish to take partial profits, I suggest having one optimizable parameter at most. This would most likely be the size of your profit target; pip or volatility-based levels are good options.

Adding more optimizable parameters will increase your risk of overfitting.

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