What is stop loss and take profit and how to set them?
Stop-loss and Take-profit are actually pending orders that trigger when the price passes certain levels. When placing such orders, the trader limits his profit and loss in advance.
Such restrictions are extremely useful when trading in a volatile market, in particular when trading on the news. In addition, a pre-set stop loss level and take profit allow you to complete the transaction automatically, even if you are not behind a computer monitor or a mobile device. Most trading strategies use these pending orders. Trading on the market without their use is extremely risky and can lead to significant losses for beginners and even experienced traders.
What is a stop loss?
Stop-loss literally means “stop loss”. In fact, this is a conscious limitation of losses in the event of their occurrence. Many traders recommend trading from the level where you can “set stops”. That is, first of all, it is necessary to find a level where you can set this very stop loss. And already from this level, calculate the take profit level, the ratio of loss to profit. If it is not possible to find an acceptable level of stop-loss installation, or it is at a level that does not allow to obtain an acceptable loss-to-profit ratio, then it makes no sense to make this transaction. It will be too risky.
Some transactions, especially medium-term and long-term ones, may require placing a stop-loss position at a considerable distance from the current price level (long stops), for example, at a distance of 500 or more points from the current market price. Not every deposit allows you to set this level of losses. In this case, it is immediately better to reduce the amount of funds that you will enter into the transaction or refuse the transaction at all.
Stop Loss Installation Methods
There are several fairly common methods for setting the stop loss level:
- For the minimum (maximum) of the previous candle when placing an order to buy (sell). This is a short stop loss model. This method is often used for intraday trading;
- Set below the last local minimum (slightly above the local maximum). Quite often, it is such stops that are knocked out by large market participants;
- Setting a stop loss behind a local level of resistance (support), taking into account the largest shadow that has broken through the level;
- Setting stop loss below / above psychological round levels;
- Setting a stop loss below or above the moving average lines;
- Setting a stop loss below / above the levels of the Parabolic SARindicator and ATR volatility indicator ;
- Setting a stop loss according to the indicators of the trading model ( Bollinger Bands , Andrews Pitch , etc.);
- Setting a stop loss below or above the Fibonacci levels;
- Setting a stop loss below / above the average daily volatility level for an instrument, taking into account the volatility levels of a particular day and time of day.
The most reliable levels for setting stop loss are strong support and resistance levels. The use of additional optional analysis to identify strong levels significantly increases the chances of the correct installation of stop loss. The combination of several methods, in case they indicate approximately the same stop-loss levels, also increases the chances of setting the optimal loss level. Of course, in any case, it is necessary to take into account the principles of money management and an acceptable level of risk for your situation.
How to set take profit?
After such as you were able to find an acceptable level of stop loss, it is much easier to establish the level of desired profit. As a rule, the ratio of losses to profits should be at least 1 to 2. The larger the ratio, the better. But limiting profits is also an important point in the transaction. You should not try to artificially raise the level at which profit taking will occur. The market situation may change, and the price may not reach the planned profit. The most frequent and noticeable points of change in the market situation is the release of important news that affects the price of this instrument or the main currency pairs in which the American dollar is present.
It is also necessary to take into account the volatility of a particular instrument. For example, if the average daily volatility in the Euro-dollar is 80 points, and the price for the current day has already passed 60 points, it is difficult to expect further significant price movement without any additional impulses. Volatility differs by day of the week, as well as by time of day.
Exit points can also be determined by checking the oscillator readings for overbought or oversold instruments. Oscillator readings should be used rather for intraday trading. Significant support / resistance levels and psychologically significant round levels can also be profit-taking levels. Fibonacci levels, as well as local maximums / minimums, can be exit points from the deal.
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