Stop loss and take profit are two of the most important order types in Forex trading, and they are the critical elements of successful Forex trading. The take-profit order is used for profit booking, while the stop-loss order is primarily for containing losses.
Usually, these orders are based on risk-reward ratios and can be set using technical analysis. Stop loss and take profit orders are similar in concept but differ in one important way – they notify the broker to exit the position either in profit or loss once the price reaches the set price level. Let’s understand more about Stop Loss and Take Profit orders.
Stop Loss Order
Stop-loss order is an essential element of a trade manager’s arsenal. You set this order whenever you enter the market, so your losses are limited to the amount you enter. Stop-loss orders are available on all major trading platforms. Setting them is usually straightforward and can be done right from your trading platform.
A stop-loss order is a pending order that saves the trader time and energy. Keeping an eye on the market can be stressful and require much concentration. It is where a stop-loss order comes in really handy, as it automatically closes your trade on a set level. Stop-loss order is available on all trading platform.
To understand it further, let’s assume that you buy EUR/USD pair at 1.2000. Now you want to place a stop-loss of 100 pips. Meaning you are limiting your losses to 100 pips only. To achieve that, you will place a stop-loss order at 1.1900, which is 100 pips away from your entry price. Now, whenever EUR/USD price drops to 1.19000, your stop-loss order will automatically execute in 100 pips loss. Remember! The stop-loss order is a pending order and it will prevent your losses from extending beyond the price level you set.
It is important to use the stop-loss order correctly. Traders often make emotional decisions about exiting a trade. They manually close a trade when they believe the market will hit their stop-loss level or when they are emotionally involved, and the price moves against their position. Some traders also extend the stop-loss, thinking their stop-loss will hit. However, these are not good practices, and you should stick to your analysis and change or cancel the stop-loss based on that.
Take Profit Order
A take-profit order is an order placed by a trader to close a position automatically at a specified profit level. A take-profit order is an intelligent way to book the profit and save time watching the market. You can place a take-profit order from the trading platform, which is sent to the broker, and it automatically triggers upon reaching a particular price level set in the order.
To understand it in detail, let’s assume that you buy the GBP/USD pair at 1.13500 and want to close the trade in 50 pips profit. To achieve your profit target, you will place a take-profit order at 1.3550, which is 50 pips away from your entry price. Now whenever the price rises to 1.3550, your take profit order will automatically execute and close the trade in 50 pips profit.
While placing a Take Profit order can be challenging in times of high volatility, they can help to protect your profits. They also help to avoid losing potential profits, as you don’t have to monitor the market all the time.
Remember! a take-profit order is also a pending order like a stop-loss order. While placing a take-profit order, it is essential to remember that the Forex broker does not always fulfill this order, and you may face slippage.
You should use a take profit order in Forex trading for several reasons. It is an integral part of your trading strategy, which defines your risk-to-reward ratio. The risk-reward ratio shows how much profit you expect versus the risk involved. The best risk-reward ratio is 1:3, meaning your profit should be three times bigger than your loss. So you can place the take profit order according to your strategy. It will ensure that you gain the profits you are targeting.
Using stop-loss and take-profit orders, you can maximize your profits while minimizing your losses.