Forex and Futures Trading - Two Simple Orders. Stop Loss Order and Take Profit Order.
- Raj Kunnukattil
- Sep 6, 2020
- 4 min read
Updated: Dec 28, 2020
What are Stop Loss and Take Profit orders? The two common order types used in trading by all. Every trader comes across these. Let's see what these order types are and how you can properly use them in your trades. Understanding the use of stop-loss and take profit orders is crucial for managing risks, exiting trades properly, and protecting profits. It is an essential tool for your trading toolkit.
Stop Loss
A Stop Loss order is a stop order placed to limit your losses if the market changes direction. For a buy order, the stop loss is placed below the market and for a sell order, the stop-loss order is placed above the market position. If the market reached the stop-price, then the stop-loss order will become a market order for a buy or a sell.
Stop-loss orders limit the amount of loss to a position. This is how you will manage risks with trading. Say, for example, you enter a long position for one E-mini contract. The risk amount you have calculated for this position is $100 dollars. You will place your stop loss at $100 dollars below your entry position. With a risk amount of $100, you can risk up to a two-point dip in the market. Anything below that, you will cross your risk thresholds. To maintain your risk levels, you will place a stop-loss order at 2 points below your entry. If the market went against your order, the stop-loss order will be executed; your trade will be closed at a 2 point loss. This is the limit you can lose without jeopardizing your trading account. This is your risk threshold. You can manage risks and execute your trading plan using stop-loss.
You can read more about Stop Loss from my Stop Order post. The link for the post is below.
Make sure you give enough breathing room for your trades. Tight stop losses are the reason for frequent stop-outs. Understand the market fluctuations and set your stop-loss orders, giving the market enough room for short-term fluctuations.
Take Profit
Take Profit is a limit order placed ahead of time to exit the position at a profit. For a long position, take profit order will be placed above the market and for a short the take profit order will be below the market. As the market reaches the take profit prices, the take profit order will become a market order for a buy or a sell.
Take Profit is a type of limit order. As the market reaches the take profit price, the take profit order will become a market order for a sell or a buy. The purpose of the take profit order is to exit the trade at profit. When you enter a position, you can specify your take profit order with the entry order. It will be based on your risk to reward ratio. In the above example, I am risking 2 points for the E-mini contract. My risk to reward ratio is 1:2; I will place my take-profit order 4 points above my entry position.
You don’t have to exit your position when the market gives you a gain of 4 points. You can continue with the position by raising your take profit price. To maximize gains, you can raise your take profit price but don’t forget to raise your stop price, so if the market turns around you will not lose all your profit.
A strategy or trading technique I use to maximize gains from my winning position is to use a staggered approach for taking profits. I use three take profit levels as below: TP1, TP2, and TP3. If the initial order is for 6 contracts, I will exit half of my position at T1. T1 is at two times the reward for the risk. I will exit the remaining 1/2 of my position at T2 and the remaining at T3.
For a risk to reward ratio of 1:2, my take profit will be at TP1. Quoting the above example for E-mini, TP1 will be at 4 points above the entry position. The next take profit order will be at TP3, which is at a risk to reward ratio of 1:3. TP2 will be 6 points above the entry position, and TP3 will be at 8 points above the entry position. This is the staggered approach to take profit. Using staggered approach, you have recovered the required gains from TP1 and TP2; now you can let TP3 run as high as you want, maximizing your gains. Use trailing stops and you can let the rest of the position chase to maximum profits.
Stop Loss and Take Profit Order Characteristics
Stop Loss and Take profit orders are placed with the entry order
Stop Loss and Take profit are kept with the broker
Trailing Stop is executed from the client
For Trailing stop to advance, the client system has to be connected with the broker
Take profit and Stop loss are OCO orders. The execution of one will cancel the other order.
Take Profit and Stop Loss will become market orders as the market touches the take profit or the stop price.
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