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Profit target and stop loss

12 Jan 2018,

Even if you’re just starting out, you’ve probably heard in various forums, articles, and videos about the profit target (PT, sometimes called take profit -TP), and about the stop the loss (SL).

 

Target Profit Definition:

Profit target is the price set on the chart where we plan to exit from the trade. If we set the PT to 100 and the market gets to the price, the trade automatically ends with a predefined profit.

Stop Loss definition:

Stop loss represents the maximum loss we want to accept with a certain trade. If we set a 50-point SL and the market will go against us and moves even further against us for another 100 points, we will receive a predefined loss of only 50 points because we have set our SL. SL may be influenced by the slippage we have already written about, but this is usually not critical and in most cases it is just few points.

This is best illustrated by the following figure:

stop loss a profit target

Situation: We sell at 1.18372, and if the price reaches our SL, we will automatically exit the trade with a predefined loss. If the price reaches the level of our PT, we take the profit.

Use of stop loss in practice

In practice, it is the best to put the stop loss in “logical locations,” but what does it mean?

stop loss v praxi

Notice how I’ve placed a stop loss above the high swing level. Downtrends are having constantly lower and lower high, so we suppose that the price should still decline, so shifting the stop loss over to the last high is an often-used step.

Some traders also put their stop loss on the S / R level with enough room for the necessary “breathing of the market”. To make it clear. When setting the SL, we must take into account natural market movements and its dynamics. The market needs to breathe in its movement, so if we put too small SL, we risk that the price will touch our small SL in the natural “breath” and then continue in our direction, but without us on the board.

stop loss v praxi 2

The size of the stop loss is different for each individual market. Some markets can work with smaller stop loss and some need bigger ones. In the last article about volatility, you’ll find a table showing average daily volatility over the last few weeks on forex markets. If the market has an average daily range (from high to low) of over 200 pips (for example, British Sterling), we must expect a higher stop loss here. Usually, however, the larger stop loss means bigger potential gain.

In general, one rule applies to the stop loss. Stop loss is what protects you from massive loss and erasing of your account. So never trade without stop loss, always have it in place! We can only skip the stop loss it if we trade the long-term trends over months and years and we do not use leverage, but that involves minimum traders.

Use of the profit target in practice

We are getting to the more pleasant part. Like stop loss, the profit target varies by market, strategy, and also by a trader.

It does not apply that PT should be larger than SL. We have to count with the percentage of profitable trades and if I have a profitable 75% of the trades, I can have SL bigger than PT and I do not mind.

We should also try to place a profit target in the logical zone, for example, if the market is in uptrend and in correction, we should place PT at the last high level. Or, we can place PT at a higher level and speculate for a longer period of decline. After the end of the CNB intervention, the dollar weakened by more than CZK 3 in a few weeks. The rules are basically similar to the SL, but with the difference that PT does not necessarily have to be set in the market, we can act differently – according to the state of the market, the indicator, for a certain time … There are many options.

In the next article we will talk about leverage.

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