Stop-loss and take-profit are two typical actions undertaken by traders in their daily activity. Properly used they allow a trader to increase the profitability of his trading. The stop-loss is that level which, if exceeded, automatically closes a position in order to avoid a high loss. Instead, the take-profit is that level which, if touched, automatically closes the position, allowing a certain gain. The levels at which these two orders are set depend on the trader’s objectives and there is no rule that applies to every case.
A typical example in which they are used is one in which the position is opened following the completion of a figure. In this situation the levels at which it is necessary to close the position (at a loss or in gain) coincide with the key levels of the figure itself. In the case of a head-and-shoulder, for example, the take-profit will be positioned at the top of the figure, while the stop-loss will be just above the neckline.
For example, if a trader buys the EURUSD pair at a value of 1.1 and sets a stop-loss of 1.0%, this means that, if the EURUSD goes down, the position will be closed at a loss of 1.09.
Holding stubbornly positions open on an account is certainly a bad choice, because by doing so, a trader risks increasing the loss even further. Also from the psychological point of view it is not the best situation.
There are 3 typical ways to set a stop-loss. The first one is to fix it based on a percentage value, deciding in advance how much to risk. If we set it at 0.1%, for example, we could at most lose 0.1% of the account. This is an easy system but considered not to be the most effective. The second one is to set it on supports and resistances, static or dynamic. Setting the stop under a support when buying, or over a resistance when selling, allows a trader to achieve greater profits. The third one is to set it based on market volatility. Suppose the volatility of the EURUSD is 100 pips, meaning that the pair can increase up or down by that amount. In this case, setting a 20 pip – stop-loss may not be an effective solution. Bollinger bands are a useful tool for measuring the volatility of a market well. Using the bands with the standard settings on the daily chart, and setting the stop-loss outside the bands, can increase the profitability of the trading.
In the most modern trading platforms there is also the ‘trailing stop-loss’ option, which allows a trader to keep a position open when it does not lose more than a certain percentage compared to the last maximum reached.
Setting the stop-loss correctly is a very important thing, as it helps a trader to respect his trading strategy, avoiding emotional influences. The size of the stop-loss is also one of those extremely important factors for assessing the overall risk, relating the maximum loss to the possible profit of the position to be opened. Usually, a stop-loss range of 1-2% of an account is recommended.