How to use Take Profit and Stop Loss in Forex trading
As the world's largest financial market, the forex market is one of the attractive ways to earn money for millions of people worldwide. However, trading in the forex market is not that simple and requires a lot of discipline and patience. One of the main pillars of trading is risk and capital management. Two essential tools for risk management are Take Profit and Stop Loss. This article aims to provide practical training for using these tools effectively to reduce the trades' risk and increase trading efficiency. Stay tuned.
Contents
What is Take Profit and Stop Loss?
Take Profit (TP) and Stop Loss (SL) are automatic orders placed at a specific price, and immediately after the market reaches that price, the trade is automatically closed. Even if your platform is closed and you are offline, the Take Profit or Stop Loss order you applied is still active, and you don't need to be constantly behind the system and check your trade. Stop Loss (SL) is an order placed to limit the amount of possible loss in a trade. Therefore, the loss limit in Buy trades is lower than the entry point, and in Sell trades, it is higher than the entry point. A take profit (TP) is an order placed to take a possible profit on a trade. Therefore, the profit limit in Buy trades is above the entry point, and in Sell trades, it is below the entry point.
Regarding Take Profit and Stop Loss, it is crucial to note that these orders are activated at the Bid price or the Ask price?
Most forex brokers display the price chart by default based on the Bid price. For example, in a rare event, the price on the chart in a sell trade may reach your take profit, but the take profit will not activate, and the market will return from there. In such cases, novice traders think the broker has manipulated their trade. But the fact is that:
Take Profit and Stop Loss in Buy trades are activated with the Bid price.
Take Profit and Stop Loss in Sell trades are activated with the Ask price.
Read more: What is Spread? The difference between Ask and Bid prices
Another important point regarding take profit and stop loss is that slippage may cause your take profit or stop loss to be activated a little further from the price you placed the order. Three of the most important factors that cause slippage are:
- News announcement time
- Market gaps
- Rapid price fluctuations
In such cases, novice traders think the broker has manipulated their trade. But in fact, the cause of this slippage is the rapid fluctuations of the market, and slippage occurs in all brokers at certain times. In this regard, Trendo Broker has been trying to minimize the possibility of slippage in trades by investing in infrastructure and upgrading the central system.
Read more: What is Slippage?
Comparing how to trade with Take Profit and Stop Loss against exiting a trade manually.
The take profit and stop loss orders are automatic and close the trade immediately after activation. In addition to using these automatic orders, you can manually close the trade (either in profit or loss). However, we recommend always using TP and SL orders because it is less risky than manually exiting the trade.
Advantages of using take profit and stop loss
1) No need to monitor the chart constantly: As a swing trader, you cannot stay on the chart for too long and follow the market frequently. That is why by using the stop loss and take profit, you no longer need to stay on the chart all the time, and it is enough to check the trade every hour.
2) No need to control emotions: After opening a trade, it is mentally hard to be patient in profit or exit the trade in loss. You will likely be influenced by your emotions and manipulate the trade if you have not used the take profit and stop loss. That is why we recommend using a take-profit and stop-loss order.
3) Lack of risk due to the news release and economic data: Important news releases, such as war news or economic data can cause big and unpredictable fluctuations in the market. Therefore, use a take profit and stop loss order to avoid such risks.
4) Proper risk and capital management: Using a specific take profit and stop loss allows you to involve a certain amount of your capital in each trade and not lose your entire capital by losing once.
Read more: How to place a take profit and stop loss
How to place a take profit and stop loss
To set the take profit and stop loss, after opening the trade, place your mouse cursor in the purple area indicated in the image below and click.
After clicking in the specified area, similar to the image below, in a new window, set your take profit and stop loss in the specified box (purple) and click Submit.
You can close your trade anytime by clicking the Close icon to close the trade manually.
Methods of placing Take Profit and Stop Loss
Determining the optimal levels of TP and SL for trades requires a comprehensive understanding of market conditions, technical analysis, and risk and capital management. Further, we will mention some practical points for setting these levels:
Risk-to-reward ratio (R/R): This ratio is the amount of risk you are willing to accept to earn a specific profit from the market. The most common risk-to-reward ratio in forex trading is 1:2, meaning your profit is twice the potential loss. For example, when you want to make a $50 profit in a trade, you are willing to risk $25 of your capital in return.
Using technical analysis: Another way to determine take profit and stop loss is to use support and resistance levels and price patterns. Identify these levels and place your orders slightly away from the price where the market is likely to reverse.
Read More: Financial markets and their trading hours
Using a fixed risk amount per trade: One method of determining the amount of take profit or stop loss is using a fixed risk amount in trades. For example, you only want to risk $30 per trade, so you set your stop loss and trading volume in a way that $30 is deducted from your trading account when the stop loss is activated.
Placing the stop loss based on the total capital: In this method, you involve a certain percentage of your total capital in each trade. For example, your total capital is $1,000, and you want to risk only 2% of the total capital per trade, so you set your stop loss at a point equal to $20. The advantage of using this method is that your risk will reduce with consecutive losses, and the possibility of losing the entire account in this method will be almost zero.
Summary
In this article from the Trendo Broker educational team, we reviewed the take profit and stop loss in forex trading and mentioned the importance of these two tools. Using take profit and stop loss increases the ability of traders to manage risk and create effective strategies. In the world of trading, the entry point is not important, what determines your success or failure in the long run is the exit point. So, before entering any trade, set the exit point from the trade and always be ready to bear a loss, because accepting a small loss is better than losing the entire account.
