17 July 2023
Many traders use stop-loss and take-profit levels as two key principles to help them choose their trade exit strategies based on how much risk they are willing to take. These thresholds are employed in both traditional and cryptocurrency markets, and they are particularly well-liked by traders whose preferred method is technical analysis.
Investors and traders who practice market timing seek to forecast future market prices and identify the best price range at which to buy or sell assets. Knowing when to leave the market is crucial under this strategy. The use of stop-loss and take-profit levels is necessary in this situation.
Trading professionals create stop-loss and take-profit levels as predetermined price targets. These predetermined levels are frequently utilized as a part of a disciplined trader's exit plan and are crucial to risk management because they are made to limit emotional trading.
Levels of take-profit and stop-loss orders
A stop-loss (SL) level is the preset price of an asset that is set lower than the current price and at which the position is closed in order to contain the investor's loss on the investment. On the other hand, a take-profit (TP) level is a predetermined price when traders close a profitable position.
Traders can set these levels to initiate automatic selling instead of utilizing market orders in real-time, which eliminates the need for constant market monitoring. For instance, the Stop Order feature on Binance Futures combines take-profit and stop-loss orders. Based on trigger price levels, the last price or mark price at the time the order is placed, and the order's status as a stop-loss or take-profit order, the system makes this determination.
Why are take-profit and stop-loss levels used?
SL and TP levels represent the current market dynamics, and those who can correctly determine their ideal values are essentially able to spot profitable trading opportunities and manageable levels of risk. In order to protect and expand your portfolio, it might be extremely important to evaluate risk utilizing SL and TP levels. By selecting less risky trades first, you are not only methodically defending your investments but also preventing the total loss of your portfolio. As a result, SL and TP levels are frequently used by traders in risk management plans.
A person's emotional state at any given time can have a significant impact on decision-making, which is why some traders rely on a predetermined strategy to refrain from trading while under the influence of strong emotions like stress, fear, or greed. When you know when to terminate a position, you may handle your trades strategically rather than irrationally and prevent trading on the spur of the moment.
To determine a trade's risk-to-reward ratio, stop-loss and take-profit levels are used.
The ratio of risk to possible profit measures how much risk is being accepted. In general, smaller risk-to-reward ratios are preferable for trading because they indicate that the potential rewards outweigh the potential hazards.
Using the following formula, you may determine risk to benefit ratio:
The risk-to-reward ratio is calculated as follows: (Entry price - stop-loss price) / (Take-profit price - entry price).
Trading professionals can select the best stop-loss and take-profit levels using a variety of techniques. The objective remains the same whether these strategies are utilized separately or in combination with other techniques: to use the available data to make more educated judgments about whether to terminate a position.
Any technical trader, whether they trade on traditional or cryptocurrency markets, is familiar with the fundamental ideas of support and resistance.
On a price chart, locations near support and resistance levels are more likely to see an increase in trading activity, whether buying or selling. Due to higher levels of purchasing activity at support levels, downtrends are anticipated to pause. Due to higher levels of selling activity at resistance levels, uptrends are anticipated to pause.
Traders that employ this technique often place their take-profit level just above the support level and stop-loss level just below the identified resistance level.
The Fundamentals of Support and Resistance are explained in great depth here.
This technical indicator removes market turbulence and smooths price action data to show the trend's direction.
Depending on the preferences of each trader, moving averages (MA) can be computed over either a short or long time frame. Trading professionals regularly monitor moving averages in search of buying or selling opportunities given by crossover signals, which occur when two distinct moving averages cross on a chart. Details about moving averages can be found in books.
A longer-term moving average is typically used by traders to determine stop-loss levels.
Some traders employ a specific percentage to determine SL and TP levels rather than a pre-determined level obtained using technical indicators. When an asset's price is 5% above or below where they entered, for instance, they may decide to close their investment. This simple strategy is effective for traders who are not particularly familiar with technical indicators.
Although we've only listed a few typical TA tools used to determine SL and TP levels, traders also utilize a variety of different indicators. This includes Bollinger Bands (BB), which gauge market volatility, the Relative Strength Index (RSI), a momentum indicator that alerts traders when an asset is overbought or oversold, and Moving Average Convergence Divergence (MACD), which employs exponential moving averages as data points.
The methods above are frequently combined to determine stop-loss and take-profit levels by traders and investors. These levels serve as technical motivations for them to exit a trade, be it to abandon a losing position or realize potential profits. Note that these levels are unique to each trader and do not guarantee successful performance. Instead, they serve as a guide to help decision-making become more strong and organized. Thus, evaluating risk by identifying stop-loss and take-profit levels or using other risk management strategies is a good trading habit.