What is Stop Loss (SL) and Take Profit (TP) and how to use it?

Both Stop Loss and Take Profit orders are basically you as a trader telling your broker when to close your trades.
A stop-loss is designed to let your broker know how much you are willing to risk with your trade.
A take profit is pretty much the exact opposite. It tells your broker how much you are willing to make as a profit with one trade and close it once you’re happy with the amount.
Both stop loss and take profit options are tools that can be used on the trading software you will be using with your brokerage. Almost every single one of them has it. But if it doesn’t you may check with your service provider since the tool is very important.
Both stop loss and take profit orders may seem very easy at one glance. You simply take a look at how much you are willing to lose or gain and set them accordingly, right? Well, technically yes. But if you don’t research how to take profits in trading, it’s likely that you will miss out on the majority of gains.
Both of these tools require studying and experience. Luckily, we’re about to do that in this guide.

The art of using Stop Loss

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How to use SL and TP orders

As already mentioned above, stop loss and take profit orders may seem very easy to learn, but they aren’t. They require months of learning about technical analysis. The process includes using charts of different assets, and through calculations with different formulas determines when a currency pair can reach its peak price, and when it could possibly decrease too much.

It’s important to note that no matter how confident you are, a profitable position can go bad within seconds, and a small loss can turn into a large one in the blink of an eye as well. Stop loss and take profit are simply unavoidable tools to use when trading.

Stop Loss and Take Profit placement should be dictated by the market and not by your rules. Your trading rules will simply help you decide whether entering the trade is worth it or not. But you cannot invent trading opportunities if the market is not giving you any.

What is stop loss and how to use it

A stop loss order is when a trader indicates when they are ready to close their position, even if they are not near their device. Forex Stop Loss and Take Profit orders are executed automatically by trading platforms. 
That’s right, a stop loss order will remain active even if you are not touching your computer or smartphone. It’s possible to simply open a trade, and leave it there overnight. If the exchange rate changes sharply, the stop loss will be there to protect your account.
What is stop loss order
But what is a stop loss order? How does it work, and how do you set it? Well, in order to answer these questions, let’s first identify stop loss order types. There are 3 types to be exact:
  • Stop Loss order
  • Market Stop
  • Trailing Stop
All of them have their own ways of setting the order.

Stop Loss order

A Stop Loss order is placed by a trader and gets triggered automatically once price reaches the predetermined point. Before entering a trade, it's important to know in advance where to place the order, in order to calculate your risks and potential rewards. As already mentioned, Stop Loss order placement should be based on a given situation. Traders usually place SL away from significant levels. For instance, if you are buying a currency pair from a resistance level, the stop should be placed below the resistance level. The idea is that if price retraces, the level might prevent the price from going further below and reverse it towards the desired direction. Once you calculate the SL distance from entry price, the next step is to calculate trade size. Generally, professional traders do not risk 1 to 5% of their trading capital per trade.

Market Stop

Market Stop orders are manual. Traders that do not use Stop Loss orders, close positions manually once balance decreases to a certain point. However, this method is not recommended as traders are influenced by the power of open position once they open trading orders. Open positions can make our market judgment skills worse. Often, an inexperienced trader hesitates to take losses and hopes the market will reverse, which often leads to blown up accounts

Trailing Stop

Trailing Stop is an automatic order type that locks in profits and limits losses when the trade goes favorably. However, trailing stops are not great in choppy and highly volatile market conditions. Trailing Stops work best in calm conditions when prices are trending gradually. 

What is a take profit in Forex and how to use it

A take profit order is the exact opposite of stop loss orders. This order type tells your broker to close the position, once the price reaches a certain point. The order is executed automatically. 
 What is a take profit in Forex
A trader simply calculates what is the maximum growth a specific currency pair can have within the next day or even hour, and then sets a take profit order accordingly. The moment the exchange rate reaches the set amount, the trade will be closed, and the trader will be able to walk away with his or her profits.

Although there is no general way of structuring your stop loss and take profit orders, most traders try to have a 1:2 risk/reward ratio. For instance, if you are willing to risk 1% of your investment, then you can target a 2% profit per trade. The risk to reward ratio can be 1:1 and a trader can still be profitable if the win rate is higher than 50%. To better understand what is take profit and stop loss, let's expand this topic a bit further below.

Stop Loss vs Take Profit

Take Profit and Stop Loss are both highly used order types. But when discussing the difference between the two in terms of importance, Stop Loss is more important. It's recommended every trade to have SL, while TP targets are not often obvious. For instance, chart patterns that signal reversals or continuations usually offer well-defined SL targets, but Take Profit targets are unknown and depend on the strength of the trend. 

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How to place Stop Loss and Take Profit levels

Deciding optimal levels for Stop Loss (SL) and Take Profit (TP) orders remains a challenging aspect of trading. Typically, setting a Stop Loss is regarded as the more straightforward task, whereas determining the appropriate level for a Take Profit order can prove to be optional and, at times, unnecessary. For instance, when adhering to market trends, accurately gauging the future intensity of a trend is often elusive. Traders, in such scenarios, enter the market, establish a Stop Loss to manage potential losses, and ride the trend for as long as its momentum persists. Conversely, there are traders who consistently employ Take Profit orders as a proactive strategy in their trading approach.

As already mentioned SL and PT placements are largely dependent on trading strategy. Each trading strategy has different tools and approaches to market analysis, let’s take a look at some of the popular ones: 

  • Support and resistance levels: Traders analyze charts to pinpoint regions of resistance and support, anticipating potential price reversals. When a price nears a specific level and is unable to surpass it, a significant level is recognized. This level is interpreted as either support or resistance, depending on the direction of the price movement.
  • Fibonacci Retracement: Fibonacci retracement is a tool used by traders to find spots where the price could turn around. It's based on Fibonacci numbers, and traders use these levels to set Stop Loss (SL) and Take Profit (TP) orders.
  • Trendlines: Trendlines play a significant role in determining stop loss and take profit targets. Traders position trendlines at the high points of price swings to better visualize potential price ranges. SL and TP orders are placed below or over the trendlines depending on the price direction. 
  • Some traders use multiple time frame analysis to determine where to place SL and TP levels. The analysis helps traders avoid opening risky trades by identifying significant levels.

Fundamental factors: economic and political events can cause significant price swings on the market triggering SL orders. Which is why many traders check the economic calendar and closely monitor political news to avoid placing orders before and during such events. 

SL and TP placement is an individual decision, depending on the situation, the basic idea is to place them in a way that maximizes winings, and limits losses.

Precision in adjusting Stop Loss (SL) and Take Profit (TP) orders requires a level of skill that distinguishes seasoned traders. This decision, ideally, should be a calculated move within the framework of a well-defined trading strategy rather than a spontaneous action.

One established strategy involves setting SL and TP levels and once in trade, never touching them, this way, traders avoid getting influenced by human emotions. Alternatively, some traders opt for a more dynamic approach, shifting the Stop Loss into a profitable position as the price charply advances in their favor. This approach allows for capitalizing on favorable market movements while still safeguarding gains.

Key Takeaways on what Stop Loss and Take Profit are

The Stop Loss (SL) and Take Profit (TP) features are basically your risk management tools. You can choose between Stop Loss, Market Stop and Trailing Stop orders when exiting a trade.
When comparing Take Profit vs Stop Loss, Stop Loss is more important. You can change orders once in trade, but it's recommended to avoid changing Stop Loss order once set, as traders get influenced by the power of open position once they are in an active trade. TP orders are often changed based on a situation.

Order placements and size should be dictated by trading setups and not on your needs. You cannot force the market to produce trading opportunities for you or the kind of opportunities you wish to trade. Every trader's main goal should be to trade the right way, and money will follow.

Stop loss and Take profit - FAQ

What is stop loss and take profit in Forex?

When you trade in the foreign exchange market, the chances of losing are pretty substantial, and one of the reasons for that is rapid price changes in the market. In order to offset these risks to some degree, you can use take profit and stop loss orders. 

First off, what is Take Profit in Forex? When you open a position, you can set the minimum price increase whereby if the asset price reaches that point, the position will automatically close to secure the generated profits immediately.

As for the stop loss Forex order, you set it in order to minimize the losses as much as possible. When you enter the market, you adjust the maximum risk that you're willing to take. Any losses below that predetermined amount will automatically force shut your current position.

How does stop loss/take profit benefit my trading?

Stop-loss prevents you from losing too much of your investment in one trade. Take profit helps you to lock-in what you’ve already earned.

They benefit you because the market is very unpredictable. At one moment everything could be going very well, and at another, it could start falling without any reason.

In addition, the orders are executed automatically and do not require your presence in front of your desktop.

Can I cancel these orders?

Of course, the perfect skill on how to take profits in trading is to always keep an eye on how things are progressing. Often traders get a clear idea where to place SL orders, however, TP order placement often depends on how trades progress. Both orders can be changed or canceled, however, it's important to be aware of the psychological pressure that trades put on the trader's mind once the position is open. Keep in mind that open positions can worsen judgment skills. It's important to plan a trade and trade the plan.

Do these orders cost anything?

No. Both Stop Loss and Take Profit orders are completely free and do not require any payments. Forex brokers do not charge traders for exiting their positions. However, keep in mind that there's a difference between selling and buying price, and spreads are naturally occurring phenomena that will affect you when closing a trade.

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