What are Stop Loss and Take Profit?
Take Profit and Stop Loss are 2 types of pending orders that are placed to close a profitable or losing position once the market reaches a specific price. Stop Loss and Take Profit are both crucial elements of Risk Management.
What is Take Profit?
In this article, we explore different trading account types and their specifications. We cover basic specifications and margin requirements, highlighting key features and considerations. Tailor your choice to match your trading goals, whether you are a beginner or an experienced trader. Gain essential insights for navigating the diverse landscape of trading platforms.
You can trade forex and other instruments on all our account types, but each trading account has its own features and specifications such as the minimum deposit required, spreads, available instruments, execution types, and commissions. The choice of account depends on your trading preferences.
What are the benefits of Take Profit?
By setting a Take Profit Order (T/P) on your trade, you can:
- Ensure a profit: If your order is successful, you’re guaranteed to make money on the trade.
- Minimise risk: By exiting the trade as soon as it hits the target price, you can take advantage of quick rises while limiting your exposure to the market.
- Avoid second-guessing: Because the trade happens automatically, you don't have to make a hasty buy/sell decision ‘in the moment’.
Take Profit is best used with a short-term strategy: You can get out of the market as soon as you hit your profit target, without letting your gains slip away in a later downturn. Take Profit can also pay off when you’re trading against the trend, as prevailing trends tend to continue over time.
What is Stop Loss?
Apart from Take Profit, an equally important pre-calculated price level used by traders today is a Stop Loss (S/L). As the name suggests, this is a type of pending order that allows the trader to set a predefined level on the price chart that closes a losing position. In other words, it ensures a minimum loss as it closes the position.
For example, a trader goes long (in other words, enters a buy position) by entering the market at 1.2980, expecting prices to rally higher. They know that the market is unpredictable, though, and that it may go in the opposite direction from their expectation. Calculating the risk before entering the market, the trader places a Stop Loss order below the entry price. If the Bid price hits the predefined Stop Loss price at 1.2880, the position is closed and a minimum loss is ensured.
Similarly, if a trader enters a sell (short) position, expecting prices to fall, they would place a protective Stop Loss order at a higher level than the entry price in case prices spike up. If the Ask price hits the predefined Stop Loss price, the position is closed and minimum loss is ensured.
Stop Loss has been designed to protect your capital by ensuring a minimum loss; it's a level set by the trader in advance according to how much they're willing to risk and/or lose.
What are the benefits of Stop Loss?
The forex market can be very volatile, and small losses can accumulate quickly. Protecting your capital with limit orders is crucial, especially when trading with leverage, which can amplify any losses. Setting a Stop Loss (S/L) will:
- Allow you to step away: You can take a break from trading, knowing there’s a cap on potential losses.
- Take the emotion out of the trade: You’ll be protected against the urge to hold the position for too long or to close it too soon.
- Mitigate risk: Exiting the trade when your limit is reached can prevent large losses if the market makes a big move against you.
Most traders aim to make a loss of no more than 2% of their total capital on any single trade. Based on this, let’s calculate the distance between the opening price and the Stop Loss in a typical forex trade.
Example Stop-Loss calculation:
- Your capital is $10,000.
- You open a EURUSD position with a volume of 1 lot (1 lot = 100,000 EUR)
- One point of price movement is worth $10.
- 2% of your capital is $200. Divide this by the value of one point’s price movement:
- 200/10 = 20
- So, the Stop Loss limit order should be placed 20 points away from the opening price of the transaction.
Two tips for setting up Stop Losses in forex:
- Don’t let emotions be the reason you move a Stop Loss. Any adjustments should be pre-determined before you place your trade.
- Trail your stop. This means letting it move in the direction of a winning trade using a ‘Trailing Stop’. It locks in profits and helps you to manage the risk if you add to your open position.
Have more questions?
Call us at: +44 2045 771951
Engage with our chatbot
