Take profits and stop losses: An essential guide to using exit orders in trading
As a trader, it’s not just about knowing when to enter the market, but also when to exit it. And one of the most critical aspects of trading is managing risk by using stop losses and locking in profits with take profits. This is where exit orders come in.
Exit orders are orders you use to tell your broker or trading provider to close a trade when the market hits a specific level. They can be used as either stops or limits, and they’re an essential tool to help manage risk and protect profits.
Take-profit orders are exit orders that allow you to automatically close a position if it reaches a specified price that is better than the underlying market’s current price. This helps traders be disciplined with their trading strategy and not chase profits unnecessarily. By setting a take profit, you’re leaving an order to automatically close the position at a predetermined level, locking in your profits.
For example, if you buy the ABC index at 4250 and plan on closing your trade if it hits 4300, earning you 50 points of profit, you can set a take profit at 4300 to automatically close the position there.
Stop-loss orders are exit orders that allow you to automatically close a position if it reaches a specified price that is worse than the underlying market’s current price. Stop-loss orders are essential tools to help minimize your losses if a price moves against you.
For example, if you’re aiming for 50 points of profit from buying ABC index but are worried that the market may reverse, you can set a stop loss at 4225 to automatically close it and limit your losses to a maximum of 25 points from your trade.
Types of stop loss
There are three main types of stop loss: standard, guaranteed, and trailing.
Standard stops work by setting a specific number of points from the current price of your trade. If the market hits your specified level, the stop triggers, and your provider closes your position.
However, there is a chance that your position won’t be closed at your precise chosen level. Markets can ‘gap,’ which means that they move directly from one level to another without hitting any prices in between. If your asset’s price gaps over your stop, then it will trigger there instead – increasing your loss.
Guaranteed stops prevent this from happening by paying a small premium, which ensures that your stop triggers at the exact level you’ve specified, even if the market gaps.
Trailing stops ‘follow’ your position if it earns you profit, helping protect profits without limiting them. Like standard stops, you set a trailing stop a specific number of points from the current price of your trade. But if the underlying market then moves in your direction, your trailing stop will move too, so it is still the same number of points below (or above, if you are short) the current price. If the market then moves against you, the stop will stay still. If the market continues to reverse, your stop will trigger, closing your position and protecting any profits you’ve made.
Other order types
In addition to the standard stop-loss and take-profit orders, there are a couple of others that can give you additional flexibility.
One-cancels-other orders (OCOs) enable you to place two orders at the same time. If one of those orders is then triggered, the other will be automatically canceled. This is particularly useful when setting both a stop loss and a take profit on an open position.
If-done orders are essentially two-step orders, where the second order is only created once the first has been triggered. They’re mostly used to create an entry order that has an exit order already attached.
Take profits and stop losses are essential tools for any trader, helping to minimize losses and maximize profits. Exit orders allow you to set maximum levels of profit or loss, while the various types of stops give you greater flexibility in managing your risk. By using these tools wisely, you can protect your investments, manage your risk, and achieve success in trading.