What is a Stop Loss? What is a Take Profit?
Both of these trading tools are essential for all traders – especially those new to trading.
One will help limit your downside whilst the other ensures your upside profits are locked in. In this article we will take a closer look at what a stop loss is and how it works as well as the ins and outs of take profit orders.
We will also take a look at the various ways to use these orders – The conventional and the lesser used, in the hope that this knowledge will assist you in your trading journey.
Let’s start with the loss limiter and safety net – The Stop Loss.
What is a Stop Loss?
A stop loss is an order that traders attach to a trade to ensure the trade is closed out if a certain price point is hit. This price point is usually to crystallise a losing trade to ensure the losses don’t continue. You will see why we say ‘usually’ later in this article.
So why should you use a stop loss? (or a Take profit order for that matter). Well, not all of us have the opportunity to monitor our positions around the clock, especially if you have numerous positions and even more so if you have different accounts with further positions. The Stop Loss order provides a safety net without the need to constantly monitor each of your positions.
Let’s say you have bought HSBC shares at 400p per share and news breaks that they have been involved in a banking scandal. If you were otherwise engaged, down the pub or even asleep – The Stop Loss order could have automatically closed your losing trade at your chosen price point of 380p before it crashes down to a price of 300p. That order has saved you 80p alone.
Now in the most basic, simple form – That’s it. That’s a Stop Loss order in a nutshell. However, in reality it’s not always that cut and dry. With most brokers, Stop Loss orders are not guaranteed. What that means is – the broker will try to close you out at the best available price after your SL has been hit.
Is this a huge concern? In the majority of cases, no. You are likely to be filled bang on your Stop Loss price in quiet to moderately active markets. If not at your Stop Loss price on the nose, then at a price extremely close to the price you set. As the market volatility increases the likelihood of you being filled away from your Stop Loss also increases. Obviously in certain products, this ‘slippage’ is more likely than others.
So, let’s say you’re trading a potentially volatile product over a potentially volatile period – So you’re a gold trader with a position on over the NFP release. If your Stop Loss is set at 1875 pre-NFP, XAU is trading at 1880 and there’s a huge beat on the NFP number. The chances are XAUUSD should gain some pretty sharp downward momentum. If the price of gold drops to 1850 and you were closed at 1873 (i.e your stop loss was slipped by 2 bucks) is that a bad result?
Probably not, right?! This is a pretty extreme example. But it gives you an idea of what’s possible. In the event I’ve described above, you’re actually unlikely to get such a good fill if the market spiked down to that lower price. Usually, the way the orders work are – once your order is triggered, then you are filled at the next available price.
So, you can see if the price of gold moved slowly from 1880 all the way down to 1850. Then the chances of you being triggered at your Stop Loss, or close to it, are high. However, in extremely volatile markets, the slippage potential becomes higher. And if the market spikes, there’s every chance that you can experience very large slippage (to the point where using the example above you could be filled at 1851…) ps – this is almost as extreme as examples come…
That might not be the most reassuring piece of trading content you’ve ever read in your life – but we are just being brutally honest. The number of traders we’ve dealt with in the past decade who call the desk or send furious emails because they haven’t been filled at their requested SL price over a crazy data release is insane. So, it’s better you understand the mechanics behind these orders before you think you are being, for lack of a better word… screwed!
Stop Loss as a Take Profit?
Stop losses aren’t only used as a safety net to prevent further losses. They can also be used on profitable trades to lock in a certain amount of profit. Say you are Long gold at 1800 and it rises to 1820. Your profit is 20 bucks. You can set a Stop loss order to close your trade at 1815 – still allowing you to use the stop loss order and take a profit!
I hope I’ve explained the advantages of using these SL orders. Using the extreme example above. Let’s say you were slipped all the way down to 1851 and the price bombs to 1800. You may not kick yourself as much right? It’s usually when we see a yoyo type move where a market spike and immediately reverses that hurt retails clients the most. As it feels like the whole world is against you – but the reality is, it’s just unlucky (and extremely frustrating)
Stop loss orders are available to assist you – not to work against you. They are there for your protection and in normal market conditions (as well as extreme conditions) can be a real asset.
What is a Guaranteed Stop Loss?
One final point on stop loss orders – We’ve been through orders that aren’t guaranteed. But there is an order that is guaranteed. Aptly named the ‘Guaranteed stop loss’.
Not all brokers offer this type of order. But they do what they say on the tin. If you set your SL at 1850 and the market shot through that price point. You would be filled at 1850. So, what’s the catch? Usually, the only catch is cost. You may be charged a commission to place this kind of order, or the cost may be built into a wider spread for the product you are trading.
If you’re already up to speed on your TP knowledge and you now have all the SL information you need – Please click here to open an account today!
What is a Take Profit?
We’ve explained what a stop loss order is and how they can act as a ‘safety net’ to the downside. Now let’s look at an order that is essentially the flip reverse of a Stop Loss – The Take profit or TP order.
Take Profit orders are normally used to lock in a certain amount of profit per trade. Ideally, a trader would have a trade open and will have performed some technical analysis on their charting to find a price target they believe a symbol will achieve. It’s at that price that they set their TP.
If the market rises (or drop if the trader is short) to that predicted level, then the order will automatically be closed, and the trader will automatically lock in their profits.
If the trader has gone long, then the take profit level will be at a higher price than the market is currently trading. And vice versa – If the trader is short then the take profit order will be set below where the market is currently trading.
Let’s take a look at a few example trades with a TP in action.
If a trader was long EURUSD at a price of 1.2100 and the price rose to a price of 1.2200 then the profit of the trade is 100 pips. But if the trader had a TP set a 1.2150 – then the order would’ve triggered at 1.2150 and the profit would’ve been locked in (50 pips profit). The trader only expected a 50 pip bounce and the order was filled perfectly but the trader in this case could’ve benefitted from a higher TP. If the TP was set at 1.2200 then the trader would’ve crystallised a 100 pip profit.
If the same trader was long EURUSD at the same price, 1.2100 – and they had a TP of 1.2200 but the market only reached a price of 1.2180 before returned all the way to 1.2100 then the TP order hasn’t been filled as the target price hasn’t been achieved. The trader could’ve taken an 80 pip profit if the TP was set correctly but in this case they are now ‘flat’.
In our final example, let’s say the trade was short EURUSD this time. At a price of 1.2250. If the price dropped to 1.2100 and the TP was set at 1.2100 then the trader has realised a profit of 150 pips! Let’s say the market now reverses all the way back to its original point of 1.2250 – does this harm the trader in any way? The answer is no, the trader has already realised their profit and closed their trade.
Like a stop loss not having to only realise a loss – a take profit doesn’t always have to take profit. i.e. If a trade was in a losing position, a TP can also be set to ensure the loss doesn’t get any bigger.
For technical analysis lovers, the take profit orders can be a fantastic way to use those levels to lock in trading profits. Guaranteed take profits aren’t as common as their stop loss equivalents and are rarely seen/used.
We hope that we’ve given you a good foundation on take profit orders. Another type of order that many traders around the globe rely on and a great tool to use in your trading strategy.
Take Profit as a Stop Loss?
Take Profits aren’t only used as a tool to crystallise a profit for the trader. They can also be used on losing trades as a safety net to ensure a loss doesn’t get too large. (This is literally coming full circle from the SL order being used as a TP) Say you are short gold at 1800 and it rises to 1810. Your loss is 10 bucks. You can set a take profit order to close your trade at 1805 – realising a loss of 5 bucks. As an example, you could use this order if you thought that 1805 may be an area of support before the market rises again and you realise that you’re in the wrong trade!
We hope that you have gained a good understanding of both sides of the coin with these orders. A stop loss order to act as your trading safety net and a take profit order to lock in your price targets. But remember they aren’t the only ways these orders can be used.
There are plenty of other options when it comes to orders, to think about. Namely, buy stops, buy limits, sell stops and sell limits. Using a combination of these orders (alongside your usual trading or use of expert advisors) can improve your trading experience greatly.
Remember that usually these orders can’t be guaranteed, especially if you are trading on MT4. And that orders on MT4 are usually filled at the next available price after your price target has been hit.
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Good luck and happy trading!