In this article, we will cover the essential things about stop loss, trailing stop, and take profit orders.
Take Profit and Stop Loss – fundamental market orders
When you place a trade on your platform, you are also asked to fill in two values: Stop loss and Take profit. These orders will automatically close your position when it reaches either the desired profit target or when the loss/risk reached your risk management limit
Let's see precisely how the stop loss and take profit work, shall we?
How does the stop-loss order work?
For instance, let’s say that you don’t want to risk more than 30 pips. For that to happen, you would want to set the trade to automatically exit when it goes 30 pips against the desired direction. So, you specify a price point as Stop loss (SL). When reached, the trade will be closed automatically.
Rule number 1: you must set a stop loss to limit the risks. That's an essential risk management principle in the world of trading.
Trailing Stop – explained
Traders often use another market order called lock in profits, sometimes referred to as a "trailing stop." This is a different type of stop-loss, as it's set at a percentage level below the current market price, not the price you bought. The price of the stop-loss adjusts with the stock price fluctuations. Using a trailing stop allows your profits to gather up while at the same time ensuring some capital gain.
Trailing stops are profit-protected, as they help you lock-in profits on trades and capping how much you could risk if the trade doesn't work out. They can work automatically with most brokers/software, or you can manually set them up.
How does the take profit order function?
Similarly, you set Take profit value to automatically close the position when the trade gets to a given point in the desired direction. For instance, you may want to specify a Take profit of 30 pips, after which you automatically wish to the trade to be closed. Since the price may change course at any time, you will want to automatically take the profit before the price moves in the other direction.
Important definition here: the ratio calculated dividing the amount of taking profit pips to the amount of stop-loss pips is defined as the risk to reward ratio. You could stumble across it, so we thought it would be best to help you understand it.
Types of Orders – how many different orders are there?
There are several types of orders, depending on how you enter and exit a trade. We'll discuss three of them now: market orders, limit order, and stop-loss orders.
Market orders are straightforward to understand. When you instantly enter the market at the best price point available, you place a market order. In the world of trading, investors also know it as an immediate execution order.
Limit Entry Orders
Whenever you buy below the market price or sell above the market price, you place a limit entry order. You will not execute the order immediately, but sometime soon, when the asset gets to the desired price point. Since the order is pending until then, it is also known as a pending order.
The advantage of pending orders is that you don't have to sit in front of your computer and keep watching charts until the market reaches the fixed price point. You can just place a pending order to automatically execute the order when the price gets there.
The two main types of limit orders: buy Limit, which means buying below the market price, and sell Limit, which means selling above the market price.
As we already explained, the stop loss order gets triggered only when the market reaches a specific price. Stop-loss order can either be a limit order type or market order type.
However, if you find yourself buying above the market price or selling below the market price, it is called a stop entry order.
The stop entry order has two types:
Buy Stop – which means buying above the market price.
Sell Stop – which means selling below the market price.
Traders could use a buy stop order when they think the price will continue upward after it reaches a precise, high enough point. And the opposite also rings true. They place a sell stop order when they think that after the price goes down to a specific level, it will resume its course in the downward direction. It’s all about market sentiment.
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Sources: Investopedia.com, Wikipedia.com, thebalance.com, babypips.com.
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