Role of Stop Losses and Take Profits in Forex

A “good entry” is when it looks probable that the trade is going to move in one direction away from the current price, and not in the other direction. So, this is a simple concept, and I think entries are the part of trading that most of us get comfortable with first.

Deep understanding of the underlying principles and mechanics is essential to professional forex trading. Stop-loss and take-profit (SL/TP) management is arguably the most important concept of forex. Stop-loss is an order that you, as a trader, send to your forex broker to limit your losses in a particular open position. Take-profit works in much the same way, letting you lock in profit when a certain price level is reached.

What Is Stop Loss?

As the name indicates, a stop-loss order is an order that closes out your trading position when your losses on that trade reach a loss amount you set when you initiate the stop loss order.

  • Stop losses should either be based on volatility or technical factors. They can never be levels where you are “right” or “wrong”, they are there to limit your maximum loss (hopefully) from any losing trade.

  • Stop losses should never be widened, but can be tightened as time from the trade entry elapses.

  • It usually makes sense mathematically make the added part of the position smaller than the initial part. This is because the first entry was more “right” than any subsequent entry.

  • Exits are very difficult. You can expect them to be the hardest challenge you face as a trader. The reason for this is because you almost never successfully execute a “perfect” exit, which would be getting out to the maximum pip before the stop loss is hit. This is ironic, as for some psychological reason we don’t really care about whether our entries are “perfect” in the same way!

  • In all but scalping, the best exit strategy is usually lies in letting the price tell you when to get out, instead of aiming for targets. If you don’t enter on targets, why exit on them?

What is Target Point/Take Profit?

A take profit order is an order that closes your trade once it reaches a certain level of profit. When your take profit order is hit on a trade, the trade is closed at the current market value.

Take profit orders are also sometimes referred to as limit orders.

  • A take profit order is often bundled with a stop loss which helps define your risk/reward. A risk to reward an appropriate trade size can go further than your trading strategy in determining how successful you are in the markets.

  • A take profit order allows you to limit your risk or exposure to the market by exiting your trade as soon as the market prints a favorable price for you and not staying in any longer.

  • Trend traders who use take profit targets are often frustrated when they’ve recognized a good trend and get out very early.

  • While the market is ranging, take profit orders are often preferred. This is because resistance levels often hold back price advances and support levels often hold up price drops.

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