What is Stop Loss and Take Profit

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This article will provide an explanation of how to use a stop loss and a take profit when trading Forex (FX). The article will cover how to place stop-losses in Forex, it will provide some examples of placing stop-losses when using certain trading strategies, how to place profit targets, and more!

It is important to know how to set a stop-loss and a take-profit in Forex, but what do stop-losses and take-profits actually represent?

These two forms are the most significant elements of trade management. A stop-loss is determined as an order that you send to your broker, instructing them to limit the losses on a particular open position or trade. As for the take-profit or target price, it is an order that you send to your broker, notifying them to close your position or trade when a certain price reaches a specified price level in profit. In this article, we will explore how to use stop-loss and take-profit orders appropriately in FX.

How to Place Stop-Losses in Forex

The first thing a trader should consider is that the stop-loss must be placed at a logical level. This means a level that will both inform the trader when their trade signal is no longer valid, and that actually makes sense in the surrounding market structure. There are several tips on how to exit a trade in the right way. The first one is to let the market hit the predefined stop-loss that you placed when you entered the trade. Another method is to exit manually, because the price action has generated a signal against your position.

Knowing how to calculate stop-loss and take-profit in Forex is important, but it is crucial to mention that exits can be end up being purely emotion-based. For instance, you could end up manually closing a trade just because you think the market is going to hit your stop-loss. In this case, you feel emotional, as the market is moving against your position, despite no price action based reason to exit manually being present.

The ultimate purpose of the stop-loss is to help a trader stay in a trade until the trade setup, and the original near-term directional bias are no longer valid. The aim of a professional Forex trader when placing a stop-loss is to place the stop at a level that grants the trade room to move in the trader’s favour.

Essentially, when you are identifying the best place to put your stop-loss, you should think about the closest logical level that the market would have to hit to actually prove your trade signal wrong. Therefore, stop-loss traders want to give the market room to breathe, and to also keep the stop-loss close enough to be able to exit the trade as soon as it is possible, if the market goes against them. This one of the key rules of how to use stop-loss and take-profit in Forex trading.

A lot of traders cut themselves short by placing their stop-loss too close to their entry point, merely because they want to trade a bigger position size. But the trap here is that when you place your stop too close, you are actually invalidating your trading edge, as you need to place your stop-loss based on your trading signal and the current market conditions, and not on the basis of how much money you anticipate to make.

Therefore, your assignment is to define your stop-loss placement prior to identifying your position size. In addition, your stop-loss placement should be determined by logic. Do not allow greed to lead you to losses.

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Examples of Placing Stop-Loss Strategies

The first strategy is known as the ‘Pin Bar Trading Strategy Stop-loss Placement’. The most logical place to put your stop-loss on a pin bar setup is usually beyond the high or low of the pin bar tail.

The second strategy example is the ‘Inside Bar Trading Strategy Stop-loss Placement’. Here, the most logical place to put your stop-loss is on an inside bar setup that is solely beyond the mother bar high or low.

The third stop-loss/take-profit strategy example is the ‘Counter-trend Price Action Trade Setup Stop-loss Placement’. For a counter-trend trade setup, your task is to place the stop-loss just beyond either the high or the low made by the setup that indicates a potential trend change.

The next example strategy is the ‘Trade Range Stop Placement’. Every trader often sees high-probability price action setups forming at the boundary of a concrete trading range. In such cases, traders may want to place their stop-loss just over the trading range boundary, or on the high or low of the setup being traded.

Consider this when learning how to use stop-loss and take-profit in FX. For instance, if we had a pin bar setup at the top of a trading range that was precisely under the trading range resistance, we would place our stop a little bit higher, just outside the resistance of the trading range, rather than just over the pin bar high.

The next example strategy is ‘Stop Placement in a Trending Market. When a trending market either pulls back or retraces to a level within the trend, we commonly have two options. The first option is that we can place the stop-loss just over the high or low of the pattern, or we can use the level, and place our stop just under it. Finally, we have come to the ‘Trending Market Breakout Play Stop Placement’. This will expand your knowledge about take-profit and stop-loss in Forex. In a trending market, we will frequently see the market pause and consolidate in a sideways manner after the trend makes a powerful move.

Such consolidation periods mostly give rise to large breakouts in the direction of the trend, and these breakout trades can potentially be lucrative for traders. There are generally two options for stop placement on a breakout trade with the trend. You can either place your stop-loss near the 50% level of the consolidation range, or on the other side of the price action setup.

How to Place Profit Targets

Frankly speaking, the most feasible approach of how to use stop-loss and take-profit in Forex is perhaps the most emotionally and technically complicated aspect of Forex trading. The trick is to exit a trade when you have a respectable profit, rather than waiting for the market to come crashing back against you, and then exiting out of fear. The difficulty here is that you will not to want to exit a trade when it is in profit and moving in your favour, as it feels like the trade will continue in that direction.

The irony is that not exiting the moment the trade is significantly in your favour usually means that you will make an emotional exit, as the trade comes crashing back against your current position. Therefore, your focus when using the stop-loss and the take-profit in Forex should be to take respectable profits, or a 1:2 risk/reward ratio or greater when they are available – unless you have predefined prior to entering, that you will try to let the trade run further.

What is the General Profit Target Placement Theory?

After identifying the most logical placement for our stop-loss, our attention should then shift to finding a logical profit target placement, as well as a risk/reward ratio. It is important to be sure a decent risk to reward ratio is viable on a trade, otherwise it is definitely not worth taking. Therefore, you have to identify the most logical place for your stop-loss, and then proceed to define the most logical place for your take-profit.

If after doing this, there is a decent risk/reward ratio possible on the trade, this trade is probably worth taking.

Nonetheless, you have to be honest with yourself in such a situation – do not ignore key market levels or apparent obstacles that are in your way in terms of reaching a satisfactory risk/reward ratio, simply because you want to enter a trade. Also, don’t forget to use the correct stop-loss/take-profit ratio. You have to analyse the general market conditions and structure, resistance and support levels, the main turning points in the market, bar lows and highs, and other important elements.

Try to define whether there is some key level that would make a logical take-profit point, or whether there is some key level obstructing the trade’s path to making an adequate profit.

Conclusion

Every trade is basically a business deal. It is essential to weigh the risk and the reward from the deal, and then to decide whether it is worth taking or not. In Forex trading, you should consider the risk of the trade, as well as the potential reward, and if it’s realistically practical to obtain it according to the surrounding market structure. To trade more profitably, it is a prudent decision to use stop-loss and take-profit in Forex.

If you would like to learn more about stop losses in Forex, make sure to read the following articles:

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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

Take-Profit Order – T/P

What is a Take-Profit Order – T/P

A take-profit order (T/P) is a type of limit order that specifies the exact price at which to close out an open position for a profit.

Basics of a Take-Profit Order – T/P

Most traders use take-profit orders in conjunction with stop-loss orders (S/L) to manage their open positions. If the security rises to the take-profit point, the T/P order is executed and the position is closed for a gain. If the security falls to the stop-loss point, the S/L order is executed and the position is closed for a loss. The difference between the market price and these two points helps define the trade’s risk-to-reward ratio.

The benefit of using a take-profit order is that the trader doesn’t have to worry about manually executing a trade or second-guessing themselves. On the other hand, take-profit orders are executed at the best possible price regardless of the underlying security’s behavior. The stock could start to breakout higher, but the T/P order might execute at the very beginning of the breakout, resulting in high opportunity costs.

Take-profit orders are best used by short-term traders interested in managing their risk. This is because they can get out of a trade as soon as their planned profit target is reached and not risk a possible future downturn in the market. Traders with a long-term strategy do not favor such orders because it cuts into their profits.

Take-profit orders are often placed at levels that are defined by other forms of technical analysis, including chart pattern analysis and support and resistance levels, or using money management techniques, such as the Kelly Criterion. Many trading system developers also use take-profit orders when placing automated trades since they can be well-defined and serve as a great risk management technique.

Key Takeaways

  • Take-profit orders are limit orders that are closed when a specified profit level is reached.
  • Take-profit orders are placed using technical analysis.
  • Take-profit orders are beneficial for short-term traders interested in profiting from a quick bump in the security costs.

Take-Profit Order Example

Suppose that a trader spots an ascending triangle chart pattern and opens a new long position. If the stock has a breakout, the trader expects that it will rise to 15 percent from its current levels. If the stock doesn’t breakout, the trader wants to quickly exit the position and move on to the next opportunity. The trader might create a take-profit order that is 15 percent higher than the market price in order to automatically sell when the stock reaches that level. At the same time, they may place a stop-loss order that’s five percent below the current market price.

The combination of the take-profit and stop-loss order creates a 5:15 risk-to-reward ratio, which is favorable assuming that the odds of reaching each outcome are equal, or if the odds are skewed toward the breakout scenario.

By placing the take-profit order, the trader doesn’t have to worry about diligently tracking the stock throughout the day or second-guessing themselves with regards to how high the stock may go after the breakout. There is a well-defined risk-to-reward ratio and the trader knows what to expect before the trade even occurs.

Stop Loss and Take Profit in Forex

Stop loss and take profit forms two important elements of trade management and is just as important as the analysis one would do before opening a position. In this article, we present a brief guide to using stop loss and take profits and also present a detailed tutorial into how to set the Stops and target levels using the MT4 trading platform.

Stop loss (SL) or stops is defined as an order that you tell or send to your broker telling them to limit the losses on an open position (or trade).

Take profit (TP) or target price is an order that you tell or send to your broker informing them to close your position or trade when price reaches a specified price level in profit. To learn more about these orders, read our article on Types of Orders in MetaTrader to learn in detail about the limit and stop orders. Stop loss and take profit levels are static in nature. In other words, the orders are triggered (and your trade is closed) when a security reaches a specified price level.

For example, if you placed a Buy order on EURUSD at 1.385 and set stop loss at 1.375 and target level of 1.395, when price moves below your entry and hits 1.375 your order is closed for a loss of 10 pips. Likewise, when price moves to 1.395, your order is closed for a profit of 10 pips.

Why set stop loss or target profit?

The reason why traders would set a stop loss or target profit levels is to manage their trades better. Imagine trading without a stop loss, which could potentially exhaust all your equity. Likewise, imagine not trading without a target price, which would basically expose your entire account equity to the market fluctuations.

What is Trailing Definition:

Trailing stops are more dynamic in nature. When using trailing stops the stop price level changes after a specified number of pips. Some trading platforms allow you to also set a trailing stop based on percentage moves as well. Trailing stops are usually used when you want to take as much of profits as possible during extreme trends. For example, setting a trailing stop of 20 Pips would mean that a new stop level would be set when price moves 20 pips in your favor.

For example, if you placed a Buy order on EURUSD at 1.385 and set the initial stop loss to 1.375 and a trailing stop of 10 Pips, then if price moves 20 pips in your favor the new stop loss would be moved to 1.385, thus making your trade break even. If price continues to move a further 20 pips, then the trailing stop moves another 10 pips in your favor setting your new stop loss order to 1.395 (thus locking in 10 pips of profit).

Trailing stops can be used alongside the take profit order as it can help to make your trade lock in as much pips as you want (and as specified by the trailing stop) instead of setting a static stop loss order.

The following chart below illustrates using stop loss, take profit and trailing stops.

How to set Stop Loss and Take Profit in MT4

On ECN account:

When you place a pending order, you can specify the entry, stop and target price levels. The following picture shows the order window when a pending order is used on the MT4 platform.

Figure 1: Stop and Target levels using pending orders

If you are using a market order, you can always update the stop and target levels by right clicking on the open position and selecting ‘Modify or Delete Order’ option, which opens the order management window allowing you to set up the stop and target levels.

Figure 2: Modifying Stop and Target Price in Market Order

To set up trailing stops, right click on the open order and select ‘Trailing Stop’ In this option you can select a pre-defined trailing stop values or choose ‘Custom’ to set up your own trailing stop value. To delete previous trailing stop values, right click to select ‘Trailing Stop’ and then select ‘Delete All’ to remove the previous trailing stop value.

Figure 3: Setting up Trailing stops

Trailing stops, stop loss and take profit levels are one of the easiest trade management actions a trader can do. Despite their simplicity, using stop loss and take profit levels can help a trader to manage their profits and losses in a more efficient manner without having to expose their capital too much and risk losing it in its entirety.

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