How Useful Is Stop-loss and Take-profit to Traders?

Last Updated: August 6, 2022
To benefit from the use of stop loss and take profit, you have to play by the following simple rules. Here’s a quick guide.
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Trading tools over the years made things much easier for traders. For instance, tools like take profit and stop loss, a trader does not have to spend the whole day staring at a screen.

All they need to do is set the parameters on where to exit the market, and the tool will do the rest automatically. Despite the increased usage of stop loss and take profit tools, many investors continue to make losses. This leads to the question, how useful is stop-loss and take-profit to traders? 

To determine the usefulness of a stop loss or a take profit, it is best to understand what they are. So what are stop loss and take profit orders? A stop-loss order aims to close a loss-making trade once it hits a specific price. The idea is to prevent more losses. On the flip side, a take-profit order is an instruction to a broker to close a profitable trade before the market reverses. 

How valuable the take profit and stop-loss tools are to traders depends on how they are applied. Some people make money while using them, while many others struggle. To benefit from the use of stop loss and take profit, you have to play by the following simple rules. 

Always Give Your Trade Some Breathing Space 

No matter how good your market analysis is, you need to accept that there will be some drawdown before the market can clear off your entry price. Simply put, markets do not move in a straight line. The trend only becomes clear after the price has moved and is close to a reversal in most cases.

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If you put a stop close to the entry point, you will likely be closed out before the trend even starts to move in your direction. Set it away from the entry point for a stop loss to work for you. This guarantees that you will not be closed out of a trade even after a slight drawdown before it starts to move in your chosen direction. 

Don’t Be Greedy When Setting a Take-profit

When setting a take profit, you must be realistic about your price projection. While there is the urge to overestimate how high or low the price can go, always remember that the price can always change instantly. When setting a take profit, set it at a level where you will make a reasonable profit without staying in the market for so long that it starts to go against you. 

One way to avoid staying in the market for too long is to set your take profit at the first significant support or resistance level. While there is always the chance that the trend could continue, you would be better off adjusting your trade later than to let greed drive you into losing all your gains. 

The above is easier said than done, though. The urge to either set a stop loss too close or a take profit too high will most likely always prevail. Luckily, variations of take-profit and stop-loss functions can help eradicate these problems. These are the trailing stop loss and take profit functions. 

What Is a Trailing Stop Loss?

Rather than setting an arbitrary stop loss, a trailing stop loss allows you to set the stop loss as a percentage. For instance, if you can’t take a more than 10% loss on a trade, a trailing stop loss allows you to set this parameter into your trade. By quantifying the amount of loss you can take, it becomes easier to use the stop-loss function. 

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What Is a Trailing Take Profit?

A trailing take profit is a take profit that turns into a stop loss once it is hit. The idea is to follow the price and avoid getting closed out too early. If you hold a long position, you can set a percentage from the current price at which you lock in your profits and close out the trade.

Recap 

The stop loss and take profit and stop-loss tools are helpful for traders. However, it depends on how they are used. It is best to give the trade some breathing space for the stop loss. For the take-profit, one needs to avoid being overly optimistic on the direction that the market can go. However, it is best to use a trailing stop loss for more accurate trades or a trailing take profit. 

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Written by Allison Langstone

Allison produces content for a business SAAS but also contributes to EarthWeb frequently, using her knowledge of both business and technology to bring a unique angle to the site.