Where should I place the Stop-Loss and the take profit? I receive this question almost every day.
It is quite funny because sometimes people send me a picture of their trade and ask me where to put
the stop loss and the take profit, forgetting that stop loss and take profit should be placed before
opening the trade, because they are a fundamental part of money and risk management.
So where should you place the stop loss and the take profit?
Of course there is no one size fits all answer to this question.
But I can share with you some important concepts to understand where to place Stop-Loss and take profit
and I'm sure that, by the end of this video, you will completely understand how to place them.
So I will not get your e-mails anymore.
Just joking.
Let's start with the stop loss and I also want to take thirty seconds to explain why I want to start
with the stop loss. People approach
Forex trading almost for one reason: to make money.
So even expert traders, most of times, when they open a new position tend to put the attention to the
potential reward that they can get.
This is completely normal from a psychological view.
Everyone here wants to get money trading the forex market.
So it's normal to think of opening a position and get money out of it.
But I want to share with you one of the most important tip that a top investor like Warren Buffett can
give to you.
First rule: never lose money.
Second rule: never forget rule number one.
In my opinion it is always better to focus on the money that you are risking rather than the money that
you can earn.
That's why I want to start with the stop loss and then have a look at the take profit. First advice
to place your stop loss is: choose a level that the price doesn't reach so easily.
The second advice is: place your stop loss at a level that proves that your analysis was wrong.
How many times you see on forex forums traders writing: the price always hits my Stop-Loss and then goes
back in the direction of the trade I placed.
Don't let a random movement or a random news to catch your stop loss.
Place it in an area that nullifies your original set up so you will know that if the price goes there,
it is because you were wrong about the trend of the market and the price is following the opposite direction.
So with the first two advice, I am basically trying to let you avoid a mistake that many aspiring traders
make.
They want to have the Stop-Loss close to the entry level because in this way they can trade with a bigger
position and they can try to make more money.
For example, if the correct stop loss is 20 pips and a trader wants to risk 200 dollars,
in this case every pip will have a value of $10.
Now traders sometimes think that if they choose a stop loss of 10 pips instead of 20 pips, they can
double their position, having a value per pip of $20 and still risking $200.
This is wrong.
A random movement can catch your Stop-Loss in minutes and you only end up with less money
your trading balance.
If the first two advice were too conservative and you may want to put your stop loss very very far
from the entry level now, here I come with the last advice.
Don't place an unrealistically large Stop-Loss.
I give you this advice because at the moment you need to choose the take profit, you will have problems
with the risk to reward ratio if you place your Stop-Loss too far.
This may look as a contradiction of the first two but with the following example you will see that you
can balance them and everything makes sense.
So here we have Canadian dollar against the Japanese yen on a 1-hour chart.
I have drawn this down trend line so the reason of the trade is quite simple.
I want to open a short position when the price is close to the downtrend line.
So the first time I considered a short position was here because you can see that the price hits the
trend line and then goes back.
So sellers were quite strong by the end of the session. But I couldn't find any good signal on the market.
Maybe this one that is a bearish engulfing pattern or here a shooting star.
But they are quite far from the downtrend line,
so I missed the chance here. Another good opportunity came here with this bearish engulfing pattern that
is very close to the downtrend line
and, actually, I took the chance to open my short position.
I have already drawn the entry level and stop loss lines that I took for this trade.
So I only need to do like this
and here we have the two lines.
The light blue line is the entry and the red line is the stop loss.
Let's have a look at the stop loss.
Does it respect the three main concepts that we have seen?
First of all, place the stop loss at a level that the price doesn't reach so easily. For the past
price action,
I would say that the price was in a kind of sideways trend and the top price has been reached with this
candle, that is quite far from my Stop-Loss level.
So definitely I would say that the stop loss is in an area that the price doesn't reach so easily.
Then we need to check if the original trading idea will be wrong in case the price hits the stop loss.
The idea is to trade according to the current trend that is expressed by this trend line.
So if the price breaks the trend line of course my idea wouldn't be valid anymore.
Now, I don't place the stop loss right after the trend line because remember that the trend line, despite
the name line, it is an area, so I can expect that the price goes a few pips higher than this line.
Let's check last advice that I have given to you: is this stop loss unrealistically too far from
the entry level.
Of course not.
The stop loss is 50 pips far from the entry level and for this trade I'm aiming for at least 50 pips
of profit.
But actually I remember that I placed a take profit of 100 pips, getting a risk to reward ratio of one
to two.
Ok, so everything should be clear about the stop loss but we also need to have a look at how to place
the best take profit for our trades. In the first course, we have talked a lot about money management and
risk to reward.
We have also seen some examples with a risk to reward ratio of 1:1 that may be fine for some
strategies. But you know that I don't like anything that goes below a 1:2 risk to reward and I strongly
recommend to choose a risk to reward ratio of 1 to 2 or higher for your trades.
Having said that, every single trade should be analyzed on its own because you will never find the exact
same situation on the market for two different trades.
But I can give you a simple two steps guideline to help you to choose the best take profit for every
single trade.
First step: place a take profit
that is twice your stop loss in order to have a risk to reward of 1:2.
Second step:
analyze if it is correct,
if it is too far or too close.
This second step needs further explanations so I'm going to open again
the previous chart on the meta trader.
The first thing I'm going to do is to draw my take profit line.
So my stop loss is 50 pips.
My take profit will be 100 pips for now. I want to change the value and I also want to change the colour
because this is my take profit line,
so I want a green color. Ok,
I need to analyze if this take profit is correct,
if it is too far or too close. This can also be expressed by three questions.
Is my take profit at a good level?
Is my take profit at an unrealistic level that the price will not reach so easily?
Am I missing a chance to get more pips and so a better take profit?
Let's check if this take profit is correct analyzing the past action of the price. Every time that the
price went down from the down trend line, the price went down by 80, 90 pips.
Also I need to consider that since the downtrend has started, the currency pair has already lost almost
200 pips.
So is a 100 pips take profit reasonable?
Of course it is. Usually the price goes down by 80-90 pips from the down trend line and there are signals
that are telling me that the downtrend is likely to continue.
So 100 pips is acceptable
as a take profit. What if the take profit was too far?
In this case you can only do two things.
You can decide to lower your take profit or you can decide not to open the trade at all.
In these situations I always opt for the second solution,
but if you still want to open the trade, make sure not to go below a one to one risk to reward ratio at
least. If the trade is not giving you a good risk to reward ratio,
it is not worth taking.
What if the take profit was too close?
If you have analyzed the market and have seen that a take profit that is twice your stop loss still
seems to close,
then you have the chance to increase the take profit and have an even better risk to reward ratio. For
this trade,
I can't realistically increase my take profit because I have seen that usually the down movements from
the trend lines are about 80-90 pips and I already have a take profit of 100 pips.
So it's not realistic to increase my take
profits in this scenario.
I consider this lecture one of the most important lecture of the entire course,
so if you still have some doubts, please ask questions in the discussion board.
You can also post your trade and have a second opinion from me or from other students.