In this article, we will speak about a stop loss and take profit in simple words.
There is no common opinion among traders with respect to the use of stop losses and take profits. Prop traders by all means use short stops in trading. The stop size should be less than a half of an average daily income.
Amateurs and beginners often use mental stops, which means that they allow losses to increase. Such traders cannot admit to making a mistake and hope that the price would reverse towards them the next moment.
Well-known traders like Alexander Elder or Larry Williams strongly recommend to use stops.
Every trading strategy should have not only rules of entering a position but also rules of exiting. That is why traders use, apart from stops, a take profit or trailing stop loss (we speak about it 2 paragraphs below).
- Sell stop loss (sell stop) is used by traders if they have a long position opened. In this case, the stop will be below the entry price.
- Buy stop loss (buy stop) is used if a short position is opened. In this case, the stop will be above the entry price.
There is also such a notion as a trailing stop. It is a stop, which moves together with the price movement manually or automatically. Initially it moves to the breakeven point and then starts to protect the growing profit. The size and step of the trailing stop are adjusted. It is important to remember that the price, as a rule, moves up and down, that is why you shouldn’t post stops very close to the position entry point.
- Sell take profit is used by traders if they have a long position opened. The take, in this case, will be above the point of entry into a trade.
- Buy take profit is used by traders if a short position is opened. In this case, the take is below the price of entry into a trade.
In a classical trading situation, a take order will be minimum three times farther from the price than a stop order.
There is an opinion that it is more efficient to use take profit in scalping during sharp impulse movements or during the range trading. A preliminarily posted take may reduce a possible profit during the trend movement.
Stop losses and take profits come into action not immediately but under certain conditions in the future. In other words, these orders wait for a trigger or fulfillment of conditions.
Let’s see how stop losses and take profits work in the trading and analytical ATAS platform in a Sberbank stock futures (SRH0) tick chart.
Example 1. We will also see in the first chart how to put a stop loss correctly. See Picture 1.
We marked the high and low of the current trading session with black horizontal lines. Let’s assume that a trader opened a long position at RUB 25,517 and wants to post a stop at the low of the trading session and to post a take at the high of the trading session.
To do it, he has to click the right mouse button over the local low of the day, below the last price. A menu will drop down, in which ATAS will offer to post a sell stop order at RUB 25,404 at this level. It means that if the current price reaches 25,404, the market sell order will automatically go to the exchange.
It is important for a trader to exit from the position as soon as possible, that is why the system sends the market order for limiting losses. But you need to pay for speed, that is why the loss-making position will be closed at the price worse than RUB 25,404. It depends on liquidity how much the price would ‘slip’.
Example 2. We will see in the second chart how to post a take profit correctly. See Picture 2.
After a trader clicks the right mouse button over the local high of the day, he will be offered a menu with the Sell Limit Order item. Posting this order means that as soon as the price reaches RUB 25,725, the limit order at the price not less than RUB 25,725 will be sent to the exchange. The limit order allows the trader to save as much profit as possible, since it is executed at the price, which is no worse than the set one.
You can set in ATAS not only individual orders but also connected with each other OCO (One-Cancels-the-Other) orders.
As soon as one OCO order is executed, the other one is automatically cancelled. A trader can post OCO stop and take orders and do not worry that one of them will stay in the system.
However, there is a nuance. If a trader closes his position manually, the stop and take orders will stay in the system. They will come into action automatically, if the price becomes equal to the set value. That is why a trader should be attentive in order not to be surprised later “what is this position doing in my portfolio?”
To cancel all posted orders, you can use the Flatten button in the Smart DOM or Close in the Chart Trader panel. See Picture 3.
Amateur traders prefer to post stops and takes on round numbers or close to significant support/resistance levels. Professional traders make money on stop order activation, that is why you shouldn’t use easy-to-see levels.
It is also useful to learn how ‘to see’ stops or takes in the chart.
In this section, we will explain how to see the position closure with the help of the Open Interest (OI) indicator. This indicator works in real time only on the Moscow Exchange.
OI grows when traders open new positions and falls when traders close their positions. Position closure could be caused by stops, takes and market orders, which were posted manually. Open Interest by itself doesn’t show what orders came into action in the market. A trader has to take into account the current tendency, psychology of the market players and significant support/resistance levels.
Let’s consider an example in the RTS index futures (RIH0) tick chart. See Picture 5.
When OI falls, traders close contracts. When OI grows, traders open new short and long positions.
The price moved down from the beginning of the trading session. Open Interest goes down in points 1, 2 and 3, which means that traders close their positions. Some of them close their positions with a profit, while the others close their positions with a loss.
We may assume that:
- some traders decided to register profit by short positions in point 1;
- short position stops could have come into action in point 2;
- traders again registered profit by short positions in point 3.
Open Interest will give you a clue about whether the current trend still has strength and what feeds it. If the price falls or grows only due to position closing and traders do not open new orders, such a movement cannot last long. A focused movement needs ‘fuel’ – new orders, that is an inflow of money and volumes.
ATAS has an advanced OI variant – OI Analyzer. It shows what sellers do and what buyers do in separate charts. OI Analyzer breaks down the Open Interest into components. It could be easier and more efficient to work with this indicator.
Protective strategies in ATAS
If a stop and take are posted automatically, a trader can:
- devote more time to trading;
- experience less stresses;
- reduce risks of incorrect posting of stops and takes.
Stops and takes are friends and not enemies of a trader. They protect his capital and are focused on its growth. Posting stop losses and take profits allows increasing the position size step by step.
It is important for a trader to have a correct attitude to stop orders and be able to use them. Activated stops do not make a trader a loser and his strategy a mistake. Traders work with probabilities. A big number of mistakes is an acceptable thing.
“In my life I missed many thousands of times, I lost hundreds of games, about 30 times, when the team trusted me with the last throw deciding the fate of the match, I missed … I lose every day – and that’s why I am a CHAMPION!”
We hope that this article helped you to become firmly convinced in the necessity of posting stop losses.
Let your take profits come into action more often!