How to Use a Stop Loss and a Take Profit in Forex Trading
You can talk about the need to set stop loss and take profit for hours, but not experienced traders are trading without using these stop orders, and a few quite risky options for forex trading strategies simply do not assume their use.
The main reason for refusing to use stop loss, as a rule, is a purely psychological reluctance to measure up to the possibility of losses, the trader turns out to set their proper level in advance and as a result, the deposit is lost. Beginners especially often neglect the recommendation to set a Stop Loss in every trade. The realization that this is a big mistake comes later, after several serious losses.
Today we will consider what is Stop Loss and how to use it, as well as touch the main rules of setting the Take Profit. In this guide, we’re going to discuss and show you the ideal Stop Loss setting. We’re also going to look at how you should plan your exits to get as much profit as possible from the markets. The exit often is a neglected aspect of a trading strategy, and in some strategies, it can even be a break factor.
Using these tools competently you will be able to trade successfully on financial markets and have a stable income. The convenience of Stop Loss and Take Profit is that when using them, there is no need to constantly monitor orders in the trading terminal.
In general, Take Profit and Stop Loss have almost the same mechanism of action, and only the "polarity" of their execution differ.
How to Place a Stop Loss in Forex
Stop Loss is a type of stop order placed by a trader in order to limit possible losses in a situation where the market went against open trade.
Stop Loss order is a necessary element of the money management rules in Forex and allows, in case of price reversal against a trade, to close an unprofitable position with a predefined loss, allowing the trader to manage his trading risks.
In modern turbulent markets, trading without a Stop Loss is simply intolerable. When one of the traders loudly declares that he never uses Stop Losses (supposedly a combination of different outputs gives him a significant advantage and allows him to work without Stop Loss orders), then professionals understand that his defeat is only a matter of time.
The inevitability of such an outcome is predetermined by the past years when an unprotected position inevitably stumbles upon a strong price drawdown or an outburst in the opposite direction from the trade. In this case, the strongest deposit can turn into a "dust" with the amount of zero in the account. The Stop Loss automatically closes the exposed position as soon as the set price value is reached. The order is stored on the server of the broker, so there is no need to keep the terminal on.
Stop Loss can be set for any type of order, including pending ones. To set a Stop Loss order in MetaTrader 4 terminal when opening a position, it is necessary to enter the desired price value in the New Order Window. For open positions, the Stop Loss order value can be changed in the "Modify/delete order" tab.
Stop Loss for a Buy order is set below the position, for a Sell order - above the position.
In practice, there are quite a few traders who do not apply for such orders in trading, closing the trades manually. This is their right because they are free to use the deposit without looking at the amount and balance, although this is an erroneous opinion. Setting Stop Loss and Take Profit you should take into account the following factors:
The size of the deposit;
Type of strategy practiced in the trading market;
Type of time frame and so on.
In fact, when trading within the daily chart, it is not recommended to insert the Stop Loss at the value of 10-15 points due to its "eating" by the market. If you place an order around 100 pips on similar conditions, there is a high risk of losses that will close profitable deals during the day.
Resistance and support levels are used to calculate orders (for the trend type of trading there are trend lines, and for the flat - its borders). Stop Loss is set slightly above the resistance level of the trend, and Take Profit is set at the support line. This is the logic that the support and resistance level of the market usually does not breakdown immediately and there is a probability of bounce. You can determine the support and resistance points using technical indicators or by analyzing previous extrema yourself. At the same time, consider the following points when calculating:
Behind the key levels, the Stop Loss places a lot of traders and their number grows rapidly over time, when trading without approaching support and resistance lines. This naturally increases the risk of order triggering and trade execution.
We do not recommend setting the Stop Loss at "round" levels (300, 150, 250), as they psychologically attract a significant part of traders.
Examples of Placing Stop Loss
In order to determine the size of the Stop Loss, you should perform only a few simple calculations.
Determine the place where the order to close a position will be set, these places are past price lows when opening long positions or the nearest highs when opening short positions. Support and resistance lines or other significant price levels also serve as reference points.
The size of losses - each trader determines it independently, ideally, it is not more than 2-5 percent per trade. That is, if you have a deposit of 5000 dollars and set the amount of loss for yourself at 5%, the loss from one transaction may not exceed 250 dollars.
Let's define the Forex lot - here we have to take into account two previous indicators, for example, first, we found out that the value of Stop Loss should be about 50 points, and the size of losses should not exceed 5% or 250 dollars.
So, one point equals 250/50=5, i.e. in our situation with a deposit of 5000 dollars, it is recommended to open positions of no more than 0.5 lots.
This is the optimal variant of calculation, but as a rule, such indicator as greed comes into effect and usually the trader having a deposit of 1000 dollars already trades the volume of not less than 1 lot, forgetting about all the risk management rules.
How to Place Profit Targets
Take Profit - a reverse pending order, upon triggering of which a position will be closed at the current profit level. Automatically fixing the profit is especially important for news and scalping strategies, where the necessary impulse can last several minutes or even seconds. It is impossible to be able to close an order manually in such a short period.
Take Profit and Stop Loss, along with lot volume, are the main elements of the risk management system or money management. Automatic fixation allows you to fully concentrate on planning a future trade, work simultaneously on several trading assets, use advisors. To set a Take Profit order in MetaTrader 4 terminal when opening a new position, you have to enter the necessary price value for triggering the order in the New Order Window. For open positions, the Take Profit order value can be edited in the "Modify/delete order" tab.
Recommendations on how to set Take Profit
There are no strict methods here, the main thing is to follow the basic principle by which Stop Loss and Take Profit are calculated. However, there are a couple of points that do not concern mathematics, when there is no constant control of the trading terminal. Basically, we should proceed from the nature of the market, the current situation on it and the applied trading tactics.
The most commonly used methods are: Local highs or lows where price reversals occurred. The method is considered to be the simplest and has proved to be excellent. When the price rises, it rarely exceeds the maximum immediately, usually there is a price reversal and its reverse movement. Therefore, when buying, you should place Take Profit near the maximum. When selling, you should pay attention to the minimum, setting Take Profit within its limits. Using this method, it is reasonable to reduce or increase Take Profit by 5-10 points depending on the situation.
Fibonacci levels. In order to determine the target, you should use the Fibonacci tool from the top menu of the terminal. Fibonacci lines at stretching based on the previous trend movement give a potential target in case of price reversal or correction. A good target, in this case, is often the 61.8% level. If the Fibonacci level coincides with the support/resistance or round level, it becomes even stronger. The combination of several levels is called Confluence.
Based on the level of the expected loss. Perhaps it is the most popular profit loss ratio is 3:1. Also, there is the Take Profit calculation depending on the size of the stop loss: SL*n, where n is a certain coefficient, usually greater than 2, providing a positive mathematical expectation of trading. The market does not affect the size of this coefficient in any way, the trader sets it taking into account his strategy and based on observations over the traded currency pair.
The next method is to set Take Profit by volatility. In this case, it is recommended to use special services (e.g. Mataf), where the average value of a candle for a certain period of time is calculated. Based on this and some other values, you can set a target. When choosing the necessary currency instrument, a trader analyzes the volatility indicators. For example, in intraday trading, it is necessary to evaluate the day candlestick. Let's assume that the average daily volatility for the EUR/USD pair is 80 points. If a trade is opened when the price has passed 20 points, then one should not count on taking profit more than 60 points. On this basis, take profit is set at 60 pips maximum:
Placing Take Profit on volatility is not the best option, but it makes sense when the trader has no other benchmarks like key levels.
The next option is to close the trade manually when a candle with a large body is formed on the chart, after which the price movement slows down or correction starts. If such a candle is formed when a trade is opened, it will bring considerable profit, and after the closing of this candle, it will be reasonable to close the trade itself.
The option of placing Take Profit when overbought or oversold in the market is also done manually. In this case, an oscillator or RSI indicator, Bill Williams, is "screwed" to the chart. When using stochastic to close a Buy order, it is necessary to wait for its lines to reach level 80. Sell order will be closed when the indicator reaches level 20 (movement should be carried out from top to bottom). The disadvantage of this method is that when the price moves in one direction for a long time, the oscillator quickly moves into the overbought/oversold zone, and as long as the price continues to move in the trend, it remains there. Bottom line - when the indicator signal is received, the trader closes the trade at the beginning of a strong trend, limiting the possibility of making money. Changing the sensitivity of the indicator can partially solve this problem.
Setting Take Profit level is a recommended but not obligatory procedure. Some traders prefer to place orders on the opposite signal. For example, this situation is possible when using strategies, where the trade is entered when moving averages cross, and the reverse crossover will be a signal to exit it or to open a new order in the opposite direction. Apart from all the above-mentioned, you should also consider such indicators as - the time of the release of important news, support and resistance levels, global lows and highs. That is places where there is a high probability of price reversal.
Summary
One of the most significant decisions you can make to decrease your risk as a trader is to use a Stop Loss. By placing a Stop Loss, you reduce the odds of finding yourself in a situation where losses quickly accumulate and make it impossible to continue your trading business. Nevertheless, something that’s equally essential is to define how and when to take profit. To set a Stop Loss and Take Profit properly, you’ll need to analyze the characteristics of the trading strategy applied. For example, a mean reversion strategy will behave quite differently from a trend following one, which requires an absolutely different approach. Still, you need to remember that every trading strategy is different and will react differently to various exit and stop-loss techniques. Consequently, you need to make sure to use backtesting to confirm your ideas, not to impose rules that harm your trading strategies!
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