What are they?

In this last lesson, you will have an insight into how to use a stop loss and take profit when trading. Stop loss and take profit is just as important as the analysis traders make before entering a new position.

Stop-loss (SL) & Take profit (TP)

Stop loss refers to an order that traders use to limit losses on any open position. Take profit, also known as target price is an order that traders use to close a position when a certain level of profit is reached. SL/TP are therefore used to exit markets in a preferable way and at the right moment.

Stop loss

The first thing to consider is that a stop loss is placed at a logical level. What is meant by that is simply that it should be a level that will both inform traders when their trade signal is no longer valid and that actually makes sense in the surrounding market structure.

Types of stop-loss

1. Percentage based Stop Loss

This is the most basic type of stop loss. It uses a pre-determined amount of a trader’s account. The percentage a trader is willing to risk varies from trader to trader. Aggressive traders tend to risk up to 10% of their account while others usually have less than 1% risk per trade.

Let say Trader A has an account with $500 and the minimum he can trade is $10,000 units. Trader A decides to trade GBP/USD as he sees that resistance at 1.5620 has been holding.

Since the GBP/USD moves over a 100 pips a day, Trader A could easily get stopped at the smallest move the GBP/USD pair make. This limit is based solely on how much he wants to lose instead of giving consideration to the given market condition.

As shown above, Trader A got stopped right at the top, since the stop loss was too tight missing out on the chance to grab over 100 pips. From this example, the danger of using a percentage stop loss is clearly shown as it forces Trader A to set his stop at an arbitrary price level.

2. Support & Resistance stop loss

Support & resistance stop loss is based on what the charts are saying. Which makes sense since sometimes prices aren’t able to push or break beyond certain levels. Therefore, it is recommended to set stops beyond the level of support and resistance.

Consider the example below:

Trader A is trading the EUR/USD pair where it has been trending down. Since price has hit the falling trendline a couple of times, it makes for a nice resistance level.

Trader A places a short order at the downtrend line at 1.3690 and a stop loss is placed at 1.3800 which is above the resistance area as shown below.

Trader A hits his first profit target but misses the second by a single pip. But by that time, Trader A had already moved his stop loss to breakeven that where he entered the short position which results in nothing being lost for Trader A.

3. Price volatility stop loss

Volatility refers to the amount by which a market can move over a certain period of time. Thus knowing by how much the price of an asset tends to move can help traders set the correct stop loss levels. Two methods can be used to set a price volatility stop loss.

Method 1:    Bollinger Bands

One way to measure price volatility is by using Bollinger bands. It works simply by setting the stop beyond the bands.

Method 2:   Average True Range (ATR)

ATR is a common indicator of price volatility. ATR is readily available on Markets.Online trading platform. All you need is set the length which is for how many hours the ATR is required for. Pretty easy, right?

Take profit

Take profits are used in conjunction with stop-loss orders. If the price of an asset rises to the take profit point, the TP order is executed and the position is closed for a profit. Take profit orders are more suitable for short term traders as it allows traders to better manage their risks.

To better understand the take profit concept, consider the example below:

Trader A spots and opens a long position on an asset. Let suppose the asset has a breakout and is expected to rise by 15% of the current levels. If the asset does not break out, Trader A would want to quickly exit the position and move to another opportunity. Therefore, Trader A creates a take profit that is 15% higher than the market price so that it sells automatically when the asset reaches that level.

There you have it! Following everything explained in this course will allow you to better manage your risk and money. But remember mastering everything you’ve learned here will take hours of practice without mentioning losses. But the key to succeeding is to never give up. Once you are able to master these concepts trading will automatically be easier.