The Essential Guide to Stop-loss and Take-Profit Orders

When do Stop-loss rules stop losses? a research paper published in May 2008 by Kathryn M. Kaminski and Andrew W. Lo, that studied the US stock market over the 54-year period from 1950 to 2004, which found that a simple stop-loss strategy provided higher returns, while at the same time limiting the potential losses. 

A stop-loss is an order placed with the broker to buy or sell a specific stock once it reaches a certain price further limiting the potential losses of the investor while increasing the winning percentage. 

Here in this read, we will delve into the concepts of stop-loss and take-profit orders and how they can help you become a loss-proof trade. Let’s dive right in! 

But, first what actually is a Stop-Loss Orders?

Definition

A stop-loss order is an order placed with a broker to buy or sell once the currency pair reaches a certain price level. It’s designed to limit potential losses by automatically closing a trade if the market moves against the trader.

Purpose

A stop-loss order protects your capital by preventing significant losses in volatile forex markets.

It implements risk management by setting a predetermined level at which you are willing to exit a losing trade.

Setting a Stop-Loss

Setting a stop-loss is the first major step and you must be careful, here are some factors to consider: 

Percentage of Capital: Determine the maximum acceptable loss as a percentage of your trading capital.

Technical Analysis: Identify key support or resistance levels, trendlines, or other technical indicators to place the stop-loss.

Types of Stop-Loss Orders

There are two major stop-loss types, let’s take a look

• Fixed Stop-Loss: A set price level where the stop-loss order is placed.
• Trailing Stop-Loss: Adjusts the stop price as the market price moves in the trader’s favor.

For example, if you buy EUR/USD at 1.1200 and set a stop-loss at 1.1150, you are limiting your potential loss to 50 pips.

Now for Take-Profit Orders

Definition

A take-profit order is placed to automatically close a trade when the currency pair reaches a specified profit level. It’s used to secure gains and exit winning trades at predetermined price points.

Purpose

It locks in profits to ensure that winning trades contribute to overall profitability and helps you avoid the temptation to stay in a trade for too long and risk giving back gains.

Setting a Take-Profit

Here are two major factors to consider while setting a take-profit

• Technical Analysis: Identify key resistance levels, Fibonacci retracement levels, or other technical factors for setting take-profit levels. The Fibonacci retracement levels are how much of a prior move the price has retraced. The levels are 23.6%, 38.2%, 61.8%, and 78.6%.
• Risk-Reward Ratio: Ensure that the potential reward justifies the risk taken.

Types of Take-Profit Orders

There are two types of take-profit orders Limit order and Partial close: 

• Limit Order: Specifies the exact price level at which the trade will be closed.
• Partial Close: Traders can close a portion of their position at different take-profit levels.

For example, if you buy EUR/USD at 1.1200 and set a take-profit at 1.1250, you aim for a 50-pip profit.

Did You Know? 

The 54 years of research on the US stock market, found that a simple stop-loss strategy provided higher returns, while at the same time limiting the potential losses. 

Best Practices for Stop-Loss and Take-Profit

Here are some of the best practices for stop-loss and take-profit orders:

Risk Management

Use stop-loss orders to control the amount of capital at risk in each trade.

Market Analysis

Conduct thorough technical and fundamental analysis to identify suitable levels for stop-loss and take-profit orders.

Adapt to Market Conditions

Adjust orders based on changing market conditions, news events, and economic data releases. Staying updated and well-informed when trading on the forex market is important.

Discipline

Stick to your trading plan and avoid emotional decision-making.

Backtesting

Test your stop-loss and take-profit strategies using historical data to assess their effectiveness.

Always remember that in forex trading, where markets can be highly volatile, having well-placed stop-loss and take-profit orders is crucial for successful risk management and consistent trading performance.

Frequently Asked Questions