How to Use Stop Loss and Take Profit in Trading
Trading

How to Use Stop Loss and Take Profit in Trading

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2 years ago

In today’s article, we will dive deeper into stop-loss and take-profit orders — tools that can make risk management a lot easier.

How to Use Stop Loss and Take Profit in Trading

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Over a week ago, we introduced you to the concept of risk management, and how you can use it to improve your trading. In today’s article, we will dive deeper into stop-loss and take-profit orders — tools that can make risk management a lot easier.

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What Are Stop Loss and Take Profit Orders in Crypto and Forex?

Stop-loss and take-profit orders are ways for a trader to automatically close an open position when the trade reaches a certain price level. Using tools like these, traders can enter trades and move on to other tasks without having to worry about the market falling or rising unexpectedly. A take-profit order will lock in profits when the price reaches the target of the trade, whereas a stop-loss order serves to take a loss and protect the trader against further downside.

Let’s look at how to use these orders in practice!

How Do You Set Stop Loss and Take Profit in Crypto and Forex?

The method of placing stop losses and take-profit orders varies slightly from platform to platform. Most trading platforms use a setup like the one below, where you can already fill in your TP and SL levels when opening the position. The exact look of the interface varies, but the idea remains the same.

Traders place their take-profit levels and stop loss based on price targets and trade invalidation. They derive their targets from all kinds of analyses, whether that be price action, moving averages or the relative strength index.

Why Place Stop Losses?

Traders use stop losses to close a position automatically when the trade turns sour to prevent further losses. By using a stop loss, a trader can focus on other activities, without having to worry about getting liquidated.

Why Place Profit Targets?

Traders have targets to lock in profits when the trade goes their way. Using take-profit orders, the trading platform automatically closes the position when the price reaches the level.

Types of Stop Loss Orders

There are multiple types of stop-loss orders used in different situations. These include sell-stop orders, stop-limit orders and trailing-stop orders. Let’s get into what the differences are!

Sell Stop Order

A sell stop order (also known as stop market order) is used to sell an asset at market price when the asset reaches a specific price. This pre-set price is called the stop price. Once the stop is triggered, the order is executed and the asset is sold at the best available market price.

Stop Limit Orders

A stop limit order is very similar to a stop market order, with the only difference being the execution. Rather than the asset being sold at market price, a limit-sell order is placed. It means that an order will only be filled if the pre-determined price is reached.

For this reason, many people prefer using sell stop orders over the stop limit order, as limit orders do not get filled most of the time. When the market price drops quickly, limit-sell orders usually go unfilled, and traders are left holding a position in an unexpected downtrend. Using sell-stop (or market) orders guarantees the closing of the position at the best price available.

Trailing Stop Order

Finally, a stop order that is gaining popularity is the trailing stop order. This type of order uses a fixed percentage below market price, and only adjusts upwards. For example, when someone enters an Ethereum long trade at $1,000 with a trailing stop of 5%, the stop is sitting at $950. Now, when the price climbs by 15% to $1150, the stop loss climbs with it and is automatically adjusted to $1,092.

If the price starts to drop, the stop loss will not move back down with it, and the trade will be executed as a market order at $1,092. This stop order is used by trend traders, who like to keep a position open for a longer time, without having to adjust their stop frequently.

Examples of Placing Stop Loss Strategies

There are many ways of using stop losses. In today’s article, we will focus on some widely-used strategies. Whether you trade the bounce, breakout or trend reversal, having stop losses in place is crucial. In any case, it involves setting a level to close a trade if the price goes against your trade.

Trading the Bounce

When trading the bounce, the most logical place to put your stop is below the low, and many traders do just that. Usually, the price bounces from support levels and traders look to long that bounce.

However, it is important to not put a stop below lows blindly. In the example above, the author of this article took a trade only after a higher low was printed, serving as confirmation of a bounce. If a trader blindly longs after the first bounce, their trade may have already been stopped in the circled area. Whether you use market structure as confirmation or something else, it is good to have some extra information that suggests a bounce is coming. This will save you lots of money over time.

Trading the Breakout

Placing your stop while trading the breakout can be difficult, especially if you are trading a trending asset. Most traders place their stops below the previous low, but this might not work in your favor. You may place your stop below certain moving averages or use a trailing stop instead when the market structure isn’t favorable.

Trading the Trend Reversal (Failure Swing)

Swing failures are a popular price pattern. More and more people incorporate it in their analysis. In short, the swing failure pattern is a liquidity engineering pattern used to fill large orders. It occurs when the price is pushed into liquidity pockets with the sole objective of filling other positions.
In times of limited liquidity, sellers engineer buying pressure to fill their orders. What’s the easier way to do it than using stop loss orders? The screenshot below is an example of a bearish swing failure pattern, where the market took the liquidity above the previous swing high before selling off.

In trading these SFPs, traders generally place their stops above the new swing high that is formed after the liquidity grab. These trades play out quickly and are ideally closed when the correction starts to slow down.

What Is the General Profit Target Placement Theory?

The general profit target placement theory talks about risk and reward, as we discussed in our recent risk management article. After placing your stop and finding a sensible take-profit area, traders must gauge if the trade has an acceptable risk-to-reward ratio that matches their win rate.

Profit targets are determined by analyzing the overall market conditions, the price action, indicators, support & resistance and other forms of analysis. Traders try to find areas where the price will have a hard time getting through and place their take-profit orders there.

What Is the 1% Rule in Trading?

The 1% rule is a generally agreed-upon maximum loss per trade. The rule suggests that you should never allow a trade to cost you more than 1% of your trading capital. For instance, if Felicia is trading with $25,000, she should never lose more than $250 per trade.

This rule can be used to calculate your trading position size by looking at your entry price and where your stop loss is. If Felicia’s stop loss is 5% lower than her entry, her position size should be $250 * 20 = $5000. When her stop loss hits, the loss will amount to $250, or 1% of her trading account.

Conclusion

Take profit orders and stop loss orders are excellent tools to automate a small part of your trading. Using tools like these, traders can enter trades and move on to other tasks without having to worry about sudden changes in prices. The take-profit order will lock in profits when the price reaches the target of the trade, whereas the stop-loss order serves to take a loss and protect the trader against further downside.

Disclaimer: This article is based on my limited knowledge and experience. It has been written for educational purposes. It should not be construed as advice in any shape or form.

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