How to Use Stop Loss and Take Profit in Forex Trading
Profitable forex traders always try to limit their losses by using a medley of orders to enter and quit the exchange. Even if they are unable to place a forex order manually. Stop-loss, take-profit, trailing stop, and forex break even are money management tools that can be used to achieve successful trading outcomes. That is why it is so important to comprehend the distinction between each kind of these orders in forex trading.
What is forex stop loss?
A forex stop loss is a type of money management order used in forex trading to limit losses from trade. It triggers a trade to be closed when losses reach a certain level. If the market price is at an unfavorable level, the forex trader will exit the trade whether through a broker or an automatic system. Thus, FX traders can protect their position even if the market suddenly changes in the other direction.
Traders often associate a stop-loss order with a long position, however, it can also protect a short position.
Examples of Placing Stop Loss
Stop loss with a long trade:
- Firstly, we place a market order, which is a buy trade of 3 lots of EUR/USD, at 1.0950.
- Then, we set the stop-loss at 1.0930.
The stop level is at 1.0930 and the buy price is 1.0950. Hence, the stop loss is worth the difference of 20 pips (1.0950 – 1.0930).
Stop loss with a short trade:
- First, we place the market order, which is a sell trade of 1 lot of GBP/USD, at 1.3100.
- Then, we set a stop-loss order at 1.3110.
The stop grade here is at 1.3110 and the sell price is 1.3100. Thus, the stop loss is worth the difference of 10 pips (1.3110-1.3100).
Forex traders will only lose what they are comfortable losing based on the amount of money they place per pip.
What is forex take profit?
Take profit in forex is the opposite of a stop-loss. It specifies the exact price at which to close out an open position for a profit. TP order immediately sells security once it reaches a certain level of profit. If the price does not reach the limit price, the order will not be filled.
Currency traders often place take-profit orders with the help of other forms of technical analysis, including chart pattern analysis and support and resistance levels.
Short-term traders who want to manage their risk should use take-profit orders. This is because they can exit a trade as soon as their profit meets the target. Avoiding the risk of a future market downturn.
Examples of Placing Take ProfitDay traders use a take-profit order to set a price at which they want to sell a security. This price must be above the initial purchase price. By doing so, traders ensure that they will make a profit on the sale. For example, if a trader decides to enter a buying position on the forex major pair EUR / USD at 1.0910 and exit at 1.0990, this would be 70 pips take profit. Depending on how much money a forex trader puts per pip, he closes the position and takes the profit. This usually happens manually or automatically.
What is Trailing stop loss in forex?
A trailing stop also called a trailing stop-loss, is similar to regular stop-loss orders, but with one additional option. Rather than staying at a fixed price level, the trailing stop-loss tracks the price activity when it pushes in a favorable direction. So, Trailing stops permit forex and crypto traders to lock in their potential profits while maintaining their positions opened until the price activity reaches retraces towards the trailing stop level by moving in the adverse path.
Here is how a trailing stop works:
When the currency pushes in a profitable direction, the trailing stop price revises or “trails” the price of this asset. In other words, it will follow the current market price in the favorable path of the trade. However, if the pair progresses in an adverse direction, the trailing stop price stays fixed at the same grade. Hence, the order will be triggered only if the price reaches the trailing stop price. This will lock in a profit or reduce a loss.
- Considering a long trade, the forex trader places a trailing stop loss under the recent market price.
- Considering a short trade, a currency trader places the trailing stop loss beyond the actual market price.
What are different types of trailing stop loss
Trailing stop based on moving average
Traders can use the MA as a trailing stop because it tracks the currency price very smoothly. They usually use the 20-period MA.
If the price direction changes and falls under the moving average line. This indicates that the upward direction is over. Forex traders will exit the trade.
Trailing stops based on ATR
Trailing stop using ATR is one of the best and most popular trailing stop-loss strategies. It is based on the current volatility of an asset. So, it reflects the price activity. Forex traders use the ATR values as a trailing stop because it gives trades enough distance to run. They place the stop a certain multiplier away (multiplier * ATR).
Here’s how it works:
- Choose the ATR multiple (it can be 3, 4, 5, etc).
- For long position, subtract “multiplier*ATR“ from the highs to calculate the trailing stop loss.
- For short position, add “multiplier*ATR” from the lows to calculate the trailing stop loss.
This is an example of 3 ATR trailing stop-loss distance:
Trailing stop based on candlesticks
In this technique, traders use a number of closed candles in the direction of the price to determine where to move the stop loss.
A good number of candles to use for this method is two or three candles.
The more candles traders use, the more they give time for the forex market to move. Conversely, the fewer candles they use, the more closely they follow price action.
In a BUY trade, use the lowest low of the last three closed candles as the area to move the stop. In a SELL trade, the highest high of the last three closed candles is used to move the stop. When a candle closes, there is a possibility to move the stop. The stop must only move in the direction of the trade.
Example of a BUY trade:
As shown in the example, you look at the last three closed candles and place the stop loss at the lowest low. When the lowest low of the previous three candles goes in a favorable direction, you move the stop to lock in more profits. In this example, the stop had moved 9 times before stopping and locking in 54 pips.
Example of a sell trade:
As shown in the chart above, look at the last three closed candles and move the stop at the highest high. The stop loss had moved 8 times, resulting in a profit of 38 pips.
What is break even in forex?Breakeven is the point at which a trading position does not make or lose money. It is also the price at which the trader entered a trading position. For example, if a forex trader buys EUR/USD at a 1.10512 price level and then closes the position at 1.10512 with zero profit and zero loss, the trader is “breakeven”. Usually, traders move their initial stop-loss price to the original entry price when the current price has moved in their favor. Here’s a breakeven example in forex trading:
- Buy a EUR/USD at 1.10512
- Price goes to 1.11000 level.
- You set stop loss at 1.10512 (break-even level).
- If the price falls to 1.10512, there will be zero profit and loss, thus, a breakeven.
The breakeven percentage is a useful statistic in trading. It calculates the number of winning trades needed to win to breakeven.
Calculation: Breakeven % = (Stop Loss / (Profit Target + Stop Loss)) x 100
- When the number of successful trades is beyond the break-even percentage, the forex trader becomes profitable.
- When the percentage of winning trades is less than the break-even calculated, the currency trader loses its money.
Breakeven using ATR:
Traders can move their stop-loss to breakeven by using a custom ATR period and ATR multiplier. For example, if the price goes up by 2 ATR from the purchase price, forex traders can choose to move the stop-loss to breakeven.
- A stop-loss is used in forex trading to limit losses. It triggers a trade to be closed when losses reach a certain level.
- A trailing stop is similar to regular stop-loss orders, but with one additional option. A trailing stop-loss follows the price when it moves in a positive direction. Instead of remaining at a specified price grade that holds constant over time.
- Trailing stops allow forex traders to lock in profits while keeping their trades open until the price reaches the trailing stop level.
- Take-profit specifies the exact price at which to close out an open position for a profit. TP order immediately sells security once it reaches a certain level of profit.
- Breakeven is the point at which a trading position does not make or lose money. It is the price at which the trader entered a trading position.