Stop loss and take profit are two essential trading orders used to control profits and losses in a forex trade. Both orders are designed to decide how much you are willing to risk or make from each trade. This may seem pretty easy at first, but knowing how to apply for each order correctly according to preset risk management rules is what differentiates successful forex traders from the crowd.
The forex market is a highly unpredictable and volatile market. That’s why calculating both potential profits and losses makes all the difference. You can’t simply ignore the possible risks that may threaten your trades. Here come stop loss and take profit as the main risk management tools that help you control your exposure to any unpredictable market moves.
What Is Stop-Loss In Forex Trading?
A stop loss (SL) order is used to automatically close a trade when the price reaches your set price level. It indicates how much money you are willing to put at risk for a single trade.
Establishing a stop-loss order is one of the most important things to do when trading Forex. Stop orders must be specified in the algorithm of every professional trading strategy. Without this, you cannot call an existing trading strategy complete.
This order can help in minimizing the losses if the price begins moving in the opposite direction, and in some cases locking profits as well. It is usually placed with a market or a pending order and can be a number of pips, percentages, or a particular price level.
The stop loss level is typically set in the opposite direction of your trade. Meaning it is put below the entry-level for long trades, and above the entry-level for short ones.
Advantages of the Stop Loss Order:
One of the biggest benefits of stop-loss orders is that they are free. A stop-loss order is like a free insurance policy that kicks in once the stop-loss price is reached, and the trade must be sold.
Furthermore, you don’t have to monitor your trade’s performance on a daily basis when you use stop-loss orders. You can take advantage of this convenience when you are on vacation or unable to monitor your trade for an extended period of time.
In addition, stop-loss orders give you a measure of emotional insecurities in your decision-making. Making profits tends to make people go undisciplined. Suppose, for example, they think giving a trade another chance will result in it recovering from the recent loss. It is likely that this delay will only result in more losses.
Forex stop loss orders are also popularly viewed as a means of preventing losses. This tool can also be used to lock in profits. A stop-loss order in this situation is sometimes referred to as a "trailing stop."
What is a Trailing Stop?
A trailing stop is a type of stop-loss that secures profits as long as the market moves in the trade’s direction, and automatically closes the trade if the market moves against it. It is set at a certain distance from market price, measured as a percentage or number of pips. It follows the market price until it moves against your Positions.
Due to the fact that it automatically monitors our positions, this tool is extremely useful when we can’t be aware of our positions.
Trading Forex With a Trailing Stop
Trailing stops, as we have discussed before, follow the price movement in real-time and stop when the market changes trends. The operation consists of the following steps:
- When a long position is taken, the trailing stop will rise in line with the market and stop when the price drops. When the price falls below the set level, the position will be automatically closed.
- A trailing stop in a short position will follow a downward movement in price and freeze when a price rises. When the price reaches the set level, the position will automatically be closed.
Trailing stop losses are only activated when the price hits a certain level. It will then be time to close the operation with benefits.
What Is a Take Profit Order?
A take profit (TP) order is set to close a trade when the price reaches profit levels. It is also an automatic order that doesn’t need your interference to be activated. While the stop loss basically aims for stopping losses, the take-profit order is intended for keeping profits.
Advantages of a Take Profit Order:
Using a take-profit order eliminates the need for traders to manually execute trades or second-guess their decisions. A take-profit order is executed at the best possible price regardless of how the underlying security performs.
Forex take profit orders are also the most useful to traders who want to manage their risk on a short-term basis. In this way, they can exit a trade as soon as their profit target is reached without risking a possible market downturn in the future. Such orders are not preferred by traders with long-term strategies since they cut into their profits.
How Do You Set Take Profit in Forex?
On contrary to the stop loss order, the take profit is set in the same direction as your trade. It is higher than the entry-level for long trades, and below the entry-level for short trades.
When setting a take profit order in your Forex trading strategy, you should keep in mind that they are not necessarily predictable and can be triggered by different market swings; they should be able to be randomly touched by price regardless of which direction you entered the trade. A successful take-profit strategy depends on your specific risk level and trading style.
Setting a modest T/P (short for a take profit) will allow you to trade with more security. As a result, you might be able to allow more flexibility with your T/P, making sense in a more volatile market. A rational median price target is always considered a safe strategy.
Stop Loss and Take Profit Explained
Both orders are applied to be executed automatically with no need for the trader to worry about manually exiting a trade. The relationship between both orders defines the risk to reward ratio. This ratio helps you identify how much money you will risk per trade. By exceeding that amount, you are violating your own rules. It’s advisable to stick to the 1% common risk rate per trade, or you can also consider a proper risk-to-reward ratio of 1:2 – 1:3, meaning that potential profits should be triple or at least double the potential loss for every single trade.
The stop loss and take profit features are designated to protect your trades. So, no matter how confident you are, it is always better to use both orders, especially in such a dynamic market. This also helps you control any emotions that can be triggered while trading. These emotions, if not well managed, can lead to bad trading decisions. Therefore, instead of worrying about how the trade is doing, you can set both SL and TP levels and relax.
How to Set Stop Loss and Take Profit in MT4
The simplest and easiest way is to enter both stop loss and take profit levels when placing a new order. Simply enter the precise price levels at which you want to take profit or stop loss.
The take-profit order will be automatically executed when the price reaches your target level, while the stop-loss will be automatically activated if the market moves against your position.
Remember that both stop loss and take profit orders will remain adjustable while your trade is active. However, setting both levels when deciding a trade is much preferable.
Stop loss and take profit orders will be shown on the chart and you can easily click and drag any of them to adjust your trade. Alternatively, you can go to the “Terminal” section at the bottom of the chart, right-click on the trade you want to modify, and choose “Modify or Delete Order”. Now you can adjust SL and TP levels by exact price or pips.
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How Stop-Loss & Tale Profit Combo Leads to Winning Trades?
Each order benefits your trading and helps you control the trading possible outcomes. The stop loss keeps you from losing too much of your capital in one trade, while the take profit helps you hold your profits in case the market decides to change its direction.
Both levels can be determined based on technical analysis of the market. So, make sure that you choose the correct levels according to market analysis and risk management plan. Check how to develop an Entry and Exit Strategy in forex trading.
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