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What are Stop Loss (S/L) and Take Profit (T/P)?

Your trading will be subject to lower risks if you use special stop orders. These types of orders assist you in your trading and allow you to make more successful trades. Every trader should know how to use them. In this article, we will learn what Stop Loss (S/L) and Take Profit (T/P) are and how they are used.

What are Stop Loss (S/L) and Take Profit (T/P)?

Stop Loss (S/L) and Take Profit (T/P) are commands for automatic closing of trades by the terminal when the price reaches a specified level. Please note that these orders can be linked to both market and pending orders.

You can place these orders in the relevant fields when opening a position. The Stop Loss order allows you to limit the level of acceptable losses, and with Take Profit you can specify a certain profit level.

Stop Loss is a stop order that traders use to minimize losses when the price moves against the preferred direction. When it reaches the specified S/L level, the position gets closed automatically. Keep in mind that S/L for long positions should always be lower than the Bid price, and for short positions it should be higher than the Ask price at the moment. The terminal verifies compliance with the order conditions.

Take Profit is a stop order that traders use in order to get a guaranteed profit from a trade when the price moves in the preferred direction. As with S/L, when the price reaches a specific level, the position is closed by the terminal if the order conditions are met. T/P should be set higher than the Bid price when opening a long position and lower than the Ask price when opening a short position.

Read more about long and short positions in the article "What are Long and Short Positions?"

Let's look at an example. We open a long position in the NZD/USD currency pair. Set the lot size at 0.01. The price is at 0.71755. Under these conditions T/P can be higher than the current price by 0.71774, and S/L - lower by 0.71721. The orders will be triggered when the Bid price reaches the levels we have set.

If we open a short position in the NZD/USD currency pair under the same conditions (lot size and current price), T/P should be set below the current price by 0.71562, and S/L - above it by 0.71595. As in the previous example, orders will be triggered when the Bid price reaches the levels we have set.

Do I need to set up Stop Loss and Take Profit?

Every trader should be aware that trading on the foreign exchange market always involves a high risk of losing the deposit. To minimize potential risks, an unofficial set of rules has been developed. It is usually referred to as money management and all profitable traders follow it.

One of the basic rules says that a trader must set up Stop Loss for every open trade. This is especially relevant for inexperienced traders who have not yet developed their own trading strategy and count more on luck than on calculation. To avoid losing your entire deposit in one unsuccessful trade, the Stop Loss order must always be used.

As for the Take Profit order, it is less critical and should be used at the discretion of the trader. Take Profit is a very convenient function for those who do not want to or cannot control manual closing of trades. The trader opens a trade, sets up Take Profit and goes about their business. The price reaches the Take Profit level, and the trade is closed with a profit without the participation of the trader.

Sometimes after the trade is closed, the price continues moving in the favorable direction, and if it were not for Take Profit, the trader could have closed it with a more significant profit. The frustrated trader might come to the conclusion that they should not use Take Profit next time. However, the Forex market is volatile and greedy traders lose their deposits quickly.

To avoid this, a trader can use a function called Trailing Stop, which moves Stop Loss to a breakeven level. Read more about Trailing Stop in the article "What is a Trailing Stop?"

In anticipation of maximum profit, a trader may miss a market reversal and close the position with a minimum profit, or even a loss. Earning the smaller planned profit is better than being left with nothing.

When should you set Stop Loss and Take Profit?

Using the Stop Loss order helps to reduce potential risks, which means it will help you keep your deposit and limit losses. But how do you know when to set Stop Loss? Each trader has their own trading strategy, and everyone decides themselves what they are willing to risk. However, it is recommended that novice traders follow the basic rules of money management to avoid losing their deposit in a matter of hours.

  1. No trade should bring a loss larger than 2% of the deposit. If the floating loss has exceeded this level, the position must be closed. Let's say the trader's balance is $3,000. The loss per trade must not be larger than 3,000 x 0.02 = $60.Now we need to calculate the volume of a position that we can open based on the planned Stop Loss level. For example, we expect to place Stop Loss at a distance of 40 points from the opening price. In this case, the point value will be 60:40 = $1.5. The price of a point in a standard trade in the amount of 1 lot is $1. Using this ratio, we calculate the maximum allowable position volume with our risk level: 1.5 / 1 = 1.5 lots.

  2. The Take Profit level must be twice as high as the Stop Loss level. In this case, even if our ratio of winning and losing trades is 50-50, in the end the size of the profit will outweigh the size of the loss.

  3. Do not open trades before the release of important macroeconomic news. Even experienced traders cannot always predict the market movement at times like this, and sharp price jumps can prematurely trigger the set Stop Loss.

Minimizing losses and increasing profits is the goal any trader strives for. Stop Loss and Take Profit are the most basic, but also extremely effective tools helping you to achieve this goal. Mastering stop orders is the key to stable profits in Forex trading.

Article last updated: 2022-10-28

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