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How To Calculate Stop Loss And Take Profit – Stop loss and take profit orders act as insurance and are essentially reverse orders. For example, if a pair is bought, when Stop Loss or Take Profit is triggered, a reverse trade (sell) will be made, locking in profit (if TP is triggered) or loss (if SL is triggered).
Stop Loss (SL) is a protective order that limits the losses a trader can incur on an open position. It automatically closes the trade when a certain level or amount of loss is reached. Stop loss is used to limit losses or lock in profits. In the latter case, the order is placed in the profitable area.
How To Calculate Stop Loss And Take Profit
Take Profit (TP) is an order that locks in profits without the trader’s involvement. When the price reaches a certain level, the order automatically closes the trade.
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Both stop loss and take profit must be set according to the trader’s strategy. For your trading stability and success, these orders are necessary. Stop losses minimize losses and enhance risk management.
Almost all trading strategies include the use of stop loss and/or take profit. Every trader has their own money management (MM) standards that tell them how much they can afford to lose on each trade. This is the strategy that tells us where to place our stop loss and take profit.
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According to MM, traders define how much they can lose if something goes wrong. The strategy tells them where their stop loss should be.
Basic Options Strategies (level 2)
Traders are using the Pin Bar strategy. At the top of the upward impulse, a Pin Bar pattern has formed and traders are planning a sell trade. In this case, the stop loss will be set behind the maximum value of the signal candlestick. The milestone to take profit is the nearest support level. The possible profit-loss ratio in this case is 3:1. In the first image you can see where the trading strategy must place stop loss and take profit.
Stop loss is usually calculated in pips from the time of entry into the trade, accounting for the sum of the tolerable losses, expressed in the base currency of the deposit. The trader must calculate the price of a pip and then place the trading volume. For example, the stop loss is 40 pips and the available loss is $100; $100/40 pips = the price of one pip is $2.25. Therefore, the trade size is 0.25 lots.
Through risk management, traders can control risk. For example, if they receive a signal with a 1 to 1 win/loss ratio, traders should think twice before entering this trade. The optimal profit-loss ratio is no less than 3 to 1.
In the image we can see a complete Pin Bar and if we calculate the trade via the strategy we see that the nearest support is as far away as the stop loss which gives a 1:1 ratio. Therefore, we can filter out this signal that does not comply with MM.
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For the next example, let’s take the simplest strategy based on two moving averages (MA) and a fractal. After the two moving averages cross, the trader receives a sell signal; then, after the trade is initiated, a stop loss is placed. The target landmark for stop loss here is the maximum fractal (so you can ensure the trade is protected from false breakouts and volatility). When the moving average crosses in the opposite direction, the trade must be closed. As long as the crossover point is unknown when opening a position, the trader will need to manually move the stop loss so that it is some distance away from the price.
If there is doubt that the price can move in the necessary direction at least 3 times farther than the stop loss distance, it is better to skip such a trade. You should never set your stop loss lower than planned due to lack of funds or desire to enter with larger trade volume, as this may result in foolish losses. Trades may be pre-closed before the price moves in the necessary direction.
Trailing Stop is a feature that automatically moves the stop a certain distance behind the price. In the MT4 terminal, this function is activated by right-clicking. Then you set a trailing stop in pips. As profits from open positions grow, the stop loss will move automatically. Remember that for trailing stop to work properly, the terminal should be open.
Compared with stop loss, take profit is not widely used. In this case, the position will move to the break-even point. Moving to breakeven means placing the stop loss in the positive zone, and if the stop loss is triggered, the position will be closed with a profit, although we did not use a take profit.
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Currently, there are many options available to make traders’ lives easier. Previously, Stop Loss and Take Profit were set manually, and if they wanted to change them, the trader had to modernize the order in several steps, whereas now, things have become much simpler. Just left-click on the order on the chart and drag it to the desired price level. Depending on the direction the order moves, either Stop Loss or Take Profit will be placed.
There are scripts and expert advisors that can automatically set stop loss and take profit levels based on set criteria for each new order. Online you can find an advisor called Auto-MM that comes with a short user guide and can calculate trading volumes and automatically set Take Profit and Stop Loss.
Many traders ignore stop losses. When they try to manually close a losing position, they begin to regret the trade and hope that the market will reverse in the desired direction. Often, such actions lead to huge losses and drawdowns. At the same time, according to MM, a properly set stop loss can help limit losses to a tolerable level.
In some cases, the use of take profit prevents traders from making more profits. The reason for this is that it is placed very close to the entry level and prevents the price from reaching its full volatility potential. In order to use protection orders correctly, traders should fully research their strategies and understand the risks involved in trading before starting operations.
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How To Calculate Stop Loss And Take Profit In Forex
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