What is Stop-loss and Take-profit: how to calculate and use stop-loss orders at Forex
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When you make transactions on the financial market, due to rapid changes in the prices of financial assets, the risk of losing the amount on the balance of your trading account is quite high. Unfortunately, according to statistics, few traders are actually guided by the rules of money management, which they read about in educational articles. Therefore, a deal opened for almost the entire amount of the deposit is not a rare occurrence.
However, FxPro clients usually follow risk management, trying to set Stop Loss and Take Profit levels for each new position. Both of these tools - Stop Loss and Take Profit - are available free of charge by default on all your FxPro trading platforms and applications.
What is Stop-loss and Take-profit
So, what is take-profit in simple words? When you open a position, you can set a level at which the deal will be automatically closed and the profit will be credited to your trading account.
Stop Loss, on the other hand, is the exact opposite. It is necessary for your deal to be closed with a loss, but with such a loss, which is psychologically acceptable for you. If the price goes below the value specified in the order settings, it will automatically lead to closing the current position.
As you understand, in such a situation, a scenario in which a trader "loses everything" cannot be realized. Hypothetically, this is possible if you open trades for the entire amount of your deposit or for a large part of it, without calculating the stop loss correctly. There are also cases of strong slippages, when it is impossible to close a position at the specified price, but this is an extremely rare situation.
Further we will tell you how exactly to set Stop Loss and Take Profit, as well as on what principle these levels can work.
Similarities and differences between SL and TP
At first glance, stop loss and take profit are very simple to use. One level helps to limit the losses and close the deal with minimal losses, and the other one does not allow you to lose the profit you have already gained, closing the position in the plus at the level you have specified. However, there are a lot of really important nuances on the questions of when and how to fix profit, as well as at what level to stop losses on a deal.
Sometimes it takes months to conduct a technical analysis of a certain asset to assess its dynamics (amplitude of price fluctuations) and to understand what stop loss and take profit levels are optimal for the chosen trading strategy. After all, you can set them too close or too far from the current price. In the first case, the chart will easily pass and fulfill your stop levels, and then turn in the opposite direction. In the second case, the losses may turn out to be colossal, or the potential profit will not be fixed.
As practice shows, many traders set a stop loss only at the beginning, when they make their first unsure trades. At the same time, they rarely set take profit, preferring to relentlessly monitor the chart and close profitable positions manually.
However, it is important to realize that no matter how confident you are or how closely you watch the chart, a trade in the plus side can turn around in a split second and no longer be so. Likewise, a small minus can increase in the blink of an eye and turn into a significant loss.
Thus, it turns out that stop loss and take profit are necessary tools for both financial and psychological management of a trader.
How Stop Loss works
A stop loss is essentially a remote order to a broker that tells them at what specific price a trader wants to close a position without even being near a computer.
In fact, a stop loss is a time-delayed order that will remain active even if you don't touch your computer or smartphone with a trading app after opening a position. For example, you can simply open a trade, specify the quote at which the stop loss should be triggered, and go about your business. At the right moment, your position will be closed at the specified level, of course, if the forecast does not come true and the price goes in the opposite direction.
How to use stop-loss orders of different types
By the way, there are several varieties of stop loss orders, three to be exact:
- Percentage Stop (Percentage-based stop loss),
- Chart Stop Stop (Stop Loss based on the chart),
- Volatility Stop (Stop Loss based on volatility).
Percentage Stop: Percentage based order
In this case, you calculate the distance from the current price at which you plan to place a stop loss based on the percentage of the amount invested in the trade that you are hypothetically willing to lose. For example, imagine that you open a position for $1000 and you are willing to lose $100 without psychological discomfort. Instead of calculating where exactly you should set your stop loss to avoid being in the "red zone" for a larger amount, you simply note that this level for you should be 10%. The level for you should be 10%.
You can calculate the exact value using the online trader's calculators on the official FxPro website.
Chart Stop: Stop Loss based on the chart
A stop loss placed based on the actual price movement is the most common of such orders.
Imagine you are looking at the EURUSD chart. The exchange rate is at 1.2321, but you assume that it may rise to 1.2401 in the near future. However, you immediately notice other technical factors that speak in favor of the price falling to 1.2296. As a result, you decide to hedge your position against the second scenario, trusting the growth forecast more. To reduce potential losses, you decide to place a stop loss at 1.2300, focusing solely on the technical picture. It can be represented by the indicators you have chosen or described in the newsletters of financial analysts/signals you trust.
Knowing exactly where you decide to set your stop loss, you can use FxPro's free calculators to calculate how much your potential loss will be. If the amount is comfortable for you, then the level can be set. Volatility Stop: Stop loss based on volatility
In this case, we are working with a parameter such as volatility: it means how often and how much a currency pair can change its price. If every second the price moves more pips than in a calm market, this is considered high volatility. The opposite situation indicates low volatility.
So, you should calculate at what percentage of volatility you are ready to continue trading, and at what percentage you will decide to close the deal in order to avoid significant losses. This is especially important for small deposits. A standard indicator Average True Range (ATR) with a minimum number of settings will help in such a visual calculation. It can be found on all FxPro platforms. The detailed principle of its use is a topic for a separate article.
How Take Profit works
Take Profit is the opposite of a Stop Loss protective order. In the case of this level, you tell your broker when to close a trade in the plus side so that you don't lose the profit you have already made.
Take profit is necessary because even if you have been making a floating (not fixed) profit on a trade during the last hour, as mentioned above, everything can change at any moment, and it is better to control this process automatically.
Your task is to calculate what maximum growth a particular currency pair can have during the next day or even hour, and then set the appropriate order to fix the profit. As soon as the rate of the selected asset reaches the set amount, the transaction will be closed and the profit will be credited to the balance.
In terms of how to place a take profit on forex, the principle is the same as for stop loss. You can rely on percentages, on technical analysis (the chart itself) or you can make a decision based on the current volatility.
Although there is no general rule for setting stop loss and take profit, most traders try to stick to a risk/reward ratio of 1:2. Most often, the balance of power is as follows: if you set Stop Loss at 10% of the trade amount, Take Profit can be set at 20%. This is not a recommendation, because market situations and trading strategies can vary greatly.
Calculation of Stop Loss and Take Profit
FxPro clients do not need to calculate these indicators themselves: online calculators are available for free on the broker's official website. You just need to specify the data you know and get a specific quote on which it makes sense to set Stop Loss and Take Profit.
If you want to understand the principle behind such calculators, or if you want to deduce these values yourself, we will tell you how to do it.
First of all, you should determine for yourself the size of potential loss and profit. Then you need to calculate the change in your balance, which will occur every time the chart goes one point up or down. The ratio between these two figures (dividing one by the other) will indicate the necessary level for setting stop levels.
The calculators are based on a formula like this:
(Target Profit or Loss / Percentage Profit or Loss) x asset pip size = Price change in pips from the current quote to set Take Profit or Stop Loss.
Take Profit / Stop Loss = Initial price +/- price change in pips.
Let's look at an example.
As a practical example, let's assume that you open a one lot buy order for the USDCHF currency pair at the price of 1.6815 and your target take profit and stop loss are $120 and $60 respectively.
To calculate forex profits in pips, you should consider that one trading lot equals 100,000 units of the base currency. In addition, the size of a pip (price step) is 0.0001.
Now we determine the value of a pip. For example, for the USDCHF pair with the current rate of 1.6815. To do this, we multiply the lot by the price step and divide by the current rate:
(100 000 * 0.0001)/ 1.6815 = 5.95$
By setting Take Profit at a distance of 20 pips from the current quote and opening a 1 lot trade, your position will potentially close with a profit of $119. If you follow the above practice of many traders, you can try to set Stop Loss at 10 pips from the current price. Then a 1 lot trade could close with a potential loss of $59.5 (Disclaimer: not a trading recommendation).
When opening a Buy trade on USDCHF, a price increase can turn into a profit, and a decrease - a loss.
Thus, the level of Stop Loss = Current Quote - Price Change in pips, comfortable for a potential loss = 1.6815 - 0.001 = 1.6805.
Let's calculate the possible Take Profit = Current Quote + Price Change in pips, sufficient to get the selected potential profit = 1.6815 + 0.002 = 1.6835.
How to set Stop Loss and Take Profit
Now we will tell you how to set stop loss and take profit on MT4 or any similar platform.
- Open MetaTrader 4.
- Click the "New Order" button in the top Menu. A pop-up window will appear where you can specify the details of your trade.
- Select the currency pair or any other asset on which you are going to trade, as well as the position volume and execution type (market or pending).
- Enter the desired Stop Loss and Take Profit values in the dialog box directly below the Volume field.
- In some cases, if you have selected Market Execution, the fields where you enter Stop Loss and Take Profit prices may not be available at this stage. You will be able to specify the values of these limit levels later, after the position has been opened.
- Go to the "Trade" tab at the bottom of the MT4 platform. This is where all open trades are located.
- Right click on the position you have just placed and select "Edit" or "Delete Order".
- In the pop-up window, you will now be able to set or change the values for stop loss and take profit. If you enter quotes that are too close or too far from the current price, the system will notify you.
In this article, we have learned that stop loss and take profit are your primary risk management tools. Regardless of whether you rely on a percentage of the trade amount, volatility or the chart itself, it is important that the decision you make is entirely your own and fits into the technical analysis strategy you have been following.
Even if you are fully confident in your prediction, it is always better to be reassured than to regret missed opportunities.
Emotions are a trader's biggest enemy, and stop loss and take profit are necessary to save your deposit in difficult situations.