Two of the most useful tools available when forex trading are the “Take Profit” and “Stop Loss” pending orders. These allow traders to define when they want to close an order, either to maximize profits or to reduce the risk of major losses.
Stop Loss and Take Profit are both amazing tools provided by Exness to help with your risk management strategies and consequently your financial returns. Let’s dig deep to see the benefits, how Stop Loss can Stop Losses, and how you can calculate the right settings for your budget. This article may well be the most useful information you’ll read all week, so perhaps take notes while reading before opening your trading account to access today’s market moves.
Emotional Trading Is Not the Answer
The trading journey always starts with the learning period. Let’s see where you are on the ladder to becoming a pro trader.
A newbie is someone who just opened a trading account, funded a couple of hundred bucks and got mixed results in the first few days. They rarely know how to use Stop Loss. This is where many first-timers stop trading through fear of loss and never try again. Newbie’s don’t fully understand the risk and are generally unsure as they select their trades for the day, and even more uncertain when it comes time to close the orders.
Newbies often look down the list of assets on the Market Watch section, stop at something familiar, check the charts, then make a trade just by “eyeballing” the trends and guessing. Again, they don’t even consider a stop order or the risk of not using one.
Newbie traders who don’t spend a few minutes each day learning about Stop Loss and the markets are the most likely to fail and lose motivation for trading and abandon the journey before they really get started.
This is a trader who has been non-stop trading for a few weeks or months and didn’t get greedy or emotionally attached to bad choices. Risk is now apparent after learning a few harsh lessons. They’ve heard about Stop Loss and how to use it to help Stop Losses, but didn’t get around to trying it yet.
An advanced trader is someone who knows what they are doing and knows exactly when to stop. They know how to properly use Stop Loss and how to calculate it. They know which assets present more risk than others and when to stop. They watch the financial news, follow their favorite companies and monitor stock prices, and they know which economic events can affect the prices of their preferred currency pairs. An advanced trader can use most of the common indicators such as Moving Averages, Bollinger Bands, and Parabolic SAR in conjunction with a stop order. Advanced traders often use Stop Loss and Take Profit, as they might not be able to constantly monitor their trades.
To be categorized as a pro doesn’t just mean that you are superb at forecasting. Pro is short for professional, as in “profession”. A pro trader is someone who makes a living from trading and will likely use Stop Loss with a high percentage of their orders. They might have other avenues of income and they might not stop working the 9 to 5, but they will consider trading or investing to be their main profession. Commonalities for pro traders include a higher than average trading fund and all the skills of an advanced trader.
The goal for every ambitious trader is to put a stop to the morning commute to work and one day go pro, but such a move cannot happen overnight. For some, it can take years of trading daily before they reach a level of confidence worthy of considering “going pro.”
To trade for years, you must be very systematic about your trades and when you close them. No matter how experienced you get, the risk of loss will always be there. That’s why newbie traders should seriously consider using Stop Loss and Take Profit from the start. Newbie traders often have an internal monologue, struggling with when to close an order. So often it sounds something like this.
The price is rising, and it doesn’t look like it will stop soon. It’s starting to crown. Is it losing momentum already? Should I sell? Rising again. Perhaps I’ll hold a little longer. Another crown, but I’m still profitable. Now the price is falling? Will it reverse again? Should I sell now? Perhaps I’ll wait for the next bullish (rising) spike, then sell. Still falling! Hardly any result now. It will bounce back. Still falling, perhaps I should have sold it. What now? I’m losing money now. It can’t fall forever. I’ll ride it out, wait for the next rally (continuous rise) then I’ll close.
This methodology and trading style is often called emotional trading. It’s when a trader follows intuition or gut feeling to decide when to open and close orders. This is exactly the opposite to those traders who use Stop Loss. If you are doing this, then you need to stop for a second and rethink your trading strategy.
While it’s possible to be profitable while emotional trading, it’s also likely that you’ll not do well in the long run. Most pro traders warn against the risk of using gut feelings. So is there a better way?
Goals and Consistency
When a trader makes an order that goes in the right direction, he or she is then faced with the question of when to close the order. When the price rises on one of your buy orders, you also see your profits rising and it’s a great feeling. It can be hypnotic and you might lose sight of when to stop. But what goes up, must come down. It’s the nature of the market. Almost every price chart you’ll ever see will look like a distant mountain range full of highs and lows. If you bought low, you’ll be looking to sell high, but just how high?
Some people trade for entertainment value and rarely consider a strategy. Excitement is an emotion that can lead traders to risk more than they should. The thrill of the win can intoxicate. People play games online all the time, but trading is not a game. It’s money, actual money. There is financial risk and it can change or affect your life in real ways.
Most people start trading the financial markets with the promise of making money. Is that you? If yes, then emotional trading is something you might try to avoid or stop entirely. Instead, start thinking about improving your skills and knowledge so you can make more informed decisions.
Assuming you’ve already studied how to identify an attractive investment using indicators and other popular tools, maximizing your trading results now depends on when you close the order. This greatly depends on your budget. If you’ve only got $10 in your account, then you don’t have a lot of flexibility and even the Stop Loss function will be limited. A millionaire can ride out poor decisions that are temporary and eventually reverse, but that’s not an option for most traders.
If your trading budget is limited, you might see better results closing an order with a modest gain and also closing an order before your losses reach a margin call. If you don’t know what a margin call is, it’s the notification that all traders fear. It’s the moment when a loss order drops to a point where your funds are at risk of zeroing-out. Many times, a trader can open an order in the morning then go to work. They get home ten hours later to see their trading account balance is zero.
How to Set Take Profit and Stop Loss Orders
Before we get into the complicated part of calculating, let’s see just how easy it is to set a Take Profit or Stop Loss order. Generally speaking, the Securities and Exchange Commission frown upon news feeds or brokers giving advice without mentioning risk, so consider this only an example of how to manage Stop Loss orders. You cannot completely avoid loss of funds with a Stop Loss.
On the app, trading is made as easy as possible, but the desktop version is equally well displayed. The chart shows the price and you need only forecast a rise or fall. Once you’ve evaluated the situation with patience and care, you tap the red SELL (expecting a fall) or the blue BUY (expecting a rise). Immediately the Take Profit and Stop Loss will appear. There is a + and – symbol which you can tap.
If you made a BUY order, then the price to Take Profit will be higher than the price you bought it. Tap the + symbol and watch the Take Profit line rise. When you see it at a level that seems feasible, start tapping the – symbol on the Stop Loss to a loss you are willing to accept. Confirm and your order is live.
If the actual price hits the high of your Take Profit, your order will be closed automatically. If the price goes the wrong way, then the Stop Loss will activate at the point you set. Easy. No fuss. Now you can sit back, have a nap, or go to work, knowing that you’ll find one of three outcomes when you check your trades later.
- You chose right, and the Take Profit took the profit
- You chose wrong and the Stop Loss stopped further losses
- The price is still dancing between the two limits.
Is Stop Loss Too Good to Be True?
It all sounds great. A tool that will Stop Loss when things go bad and automatically Take Profits when things go your way… so what’s the catch? To show the risk, we need to enter the realm of “what if…?” “What if” scenarios will eventually show if you trade long enough. Let’s use some numbers to demonstrate the weakness of setting a Take Profit and Stop Loss order.
- You deposit $100
- You set leverage at 1:100
- You choose Gold (XAUUSD) at the price of $2000.
- You invest $100 in a BUY order and get a market position of $10,000
If the Gold price rises to $2100, your Take Profit will close the order with a profit of $500. This might sound like a pretty good trading strategy. Gold prices regularly rise and fall by as much as $150 each month. If you go the right way, you’re looking at some pretty good returns from just a $100 deposit/investment.
That’s Take Profit. That’s the “happy” ending version. But where there’s reward, there’s always risk. What about Stop Loss? Let’s say you only want to risk $50. To Stop Losses from exceeding $50, you’d need to set Stop Loss to activate when the price falls by just $10.00 to $1990.
This is where a lot of traders get home to check their trades and jump for joy seeing that Gold hit $2100+. Then they see that their Stop Loss was activated, and they lost fifty bucks. Market prices are a rollercoaster, and Netflix dipped slightly and activated the Stop Loss before going on to rise high.
There are ways to avoid such disappointments. Lowering leverage to 1:20 means the dip can go as low as $1950 before activating the Stop Loss, but then your profits from the rise to Take Profit level would reach only $100.
Account level, leverage, Take Profit, and Stop Loss are all connected, and finding the right balance is essential if you want to have a long and exciting trading journey with the aim to turn pro one day.
Now you know who likes to use a Take Profit and Stop Loss order, what’s the risk, and what’s the benefit. Let’s look at the calculation part to better understand the mechanics behind these two powerful tools.
The Calculation Part
When deciding where to place your Take Profit or Stop Loss pending orders when forex trading, you can make use of a formula very similar to the ones we’ve gone through above.
To do so, simply do the following:
(Target profit/point profit) x point size = price change in points
Then you calculate your price change per point and, depending on whether you opened with a BUY order or a SELL order, you do the following:
- Take Profit = opening price + price change in points
- Stop Loss = opening price – price change in points
- Take Profit = opening price – price change in points
- Stop Loss = opening price + price change in points
Let’s take a look at a quick example of a Take Profit/Stop Loss order.
You open a BUY order of one lot of EURUSD at 1.2320. You decide that you want to Take Profit at USD 100, and your Stop Loss at USD 50.
Let’s do the Take Profit order first.
- (100/10)x0.0001 = 0.001
Remember that to calculate “point profit” you take lot size x contract size x point size, which in this case is 1 x 100,000 x 0.0001
- 1.2320+0.001 = 1.2330
We can therefore see that, if you want to get USD 100 profit off this order, you’ll need to set your Take Profit at 1.2330.
Now let’s do the Stop Loss.
- (50/10)x0.0001 = 0.0005
- 1.2320-0.0005 = 1.2315
Therefore, if you want to restrict your losses to just USD 50, you need to set your Stop Loss to 1.2315.
So there you have it. How to incorporate risk calculation and use Stop Loss and Take Profit in your trading strategy. If you haven’t already, open an account with Exness then make a deposit that matches your financial situation and trading goals. The higher your deposit, the more flexibility you’ll have when it comes to leverage. It is, of course, your choice completely, but if you’re starting with $100-$200 deposit, consider one of the lower leverage options and keep your trades and expectations modest.
Take a look at the many incredible trading opportunities available on the trading platform, then take the calculator from the kitchen drawer and start running the numbers before you hit the BUY or SELL button.
How much are you risking, what result can you hope for, and how much movement in the wrong direction will trigger a Stop Loss?
Always consider risk before reward. How much are you risking, what result can you hope for, and how much movement in the wrong direction will trigger a Stop Loss? Ask yourself how long you are willing to leave the order open. One day? One week?
Let’s say one day only and let’s stick to Netflix for the example. Just how much does the price fluctuate in a single day? You might not want to focus on the most extreme spikes and crashes on the chart. What’s the average movement? When setting Take Profit, just how much can it move in just one day? Be realistic about your expectations. Stop Loss is not about the price of the asset, it’s about protecting your funds. If the price doesn’t go your way, make sure you have enough in your trading account to fight another day. Pro traders absorb their losses by adjusting their daily trading budget accordingly. When they win, they raise the budget. When they lose, they lower the budget. Be conservative from the start until your knowledge, confidence level, and history of profitable trades is rising. Only then should you get ambition and start dreaming about being a pro trader. Be consistent with your Stop Loss and Take Profit strategy. When you find the right balance of risk and reward, stick to it.
Have a go yourself by forex trading today!