Take Profit and Stop Loss are 2 types of the pending orders that are placed to close a profitable or losing position once the market reaches a specific price. In this article, we will talk about:
- What is take profit
- What are the benefits of Take Profit?
- When should I use a Take Profit Order?
- Can I change a Take Profit Order?
- What is Stop Loss?
- Why use a Stop Loss Order?
- Where should I set my Stop Loss?
- Can I change a Stop Loss Order while my position is open?
- Three rules for setting up Stop Losses in forex
What is Take Profit?
Take Profit is a type of pending order that's placed to close a profitable position once the market reaches a specific price. As the name suggests, it allows the trader to set a predefined level to lock in profits. In other words, it takes the profit as it closes the position. Take Profit is abbreviated as (T/P).
For example, a trader goes long (opens a buy position) by entering the market at 1.2980, expecting prices to rally higher. They want to benefit from the rise, so they place a Take Profit order at a level higher than the entry price, 1.3180. If the Bid price hits the predefined Take Profit price at 1.3180, the position is closed and profits are locked in.
Similarly, if a trader goes short (enters a sell position), expecting prices to fall, they place a Take Profit order at a lower level than the entry price because they want to benefit from a fall. Let’s say this trader entered the market at the same price, 1.2980. In this case, they decide to place their Take Profit at 1.2880. If the Ask price hits the predefined Take Profit price, the position is closed and any profit is locked in.
On Market Execution accounts, you can specify a Take Profit or Stop Loss order when placing a pending order to enter the market.
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’.
When should I use a Take Profit Order?
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.
Can I change a Take Profit Order?
You can adjust or cancel a Take Profit while your forex trade is open and you’re monitoring the market. You can also add a Take Profit to a forex position that’s already open.
What is Stop Loss?
Apart from Take Profit, an equally important pre-calculated price level used by traders today is called Stop Loss. 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. Stop Loss is abbreviated as (S/L).
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 than 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. It’s important to remember that on Market Execution accounts, Stop Loss or Take Profit orders are placed when placing a pending order to enter the market.
Stop Loss and Take Profit are both crucial elements of Risk Management.
Why use a Stop Loss Order?
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.
Where should I set my Stop Loss?
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.
Please be aware:
You can't completely avoid trading losses with Stop Loss orders. They are just one method to potentially plan for potential losses.
Can I change a Stop Loss Order while my position is open?
You can adjust or cancel a Stop Loss order while your trade is open and you’re monitoring the market. You can also add a Stop Loss to a position that’s already open.
Three rules 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 manage the risk if you add to your open position.
- Never widen your stop. This is like not having a stop at all – it’ll only increase your risk and the amount you could lose.
