Résumé
Stop-loss and Take-profit levels are two fundamental concepts that many traders rely on to determine their market exit strategies based on the risk they are willing to take. These thresholds are used in both traditional and crypto markets, and are particularly popular among traders whose preferred approach is technical analysis.
Introduction
Forecasting market direction is a strategy where investors and traders try to predict future market prices and find an optimal price level to buy or sell assets. As part of this approach, knowing when to exit the market is essential. This is where Stop-loss and Take-profit levels come into play.
Stop-loss and Take-profit levels are price targets that traders set in advance. Often used as part of a disciplined trader's exit strategy, these predetermined levels are designed to keep emotion-based trading to a minimum and are essential for risk management.
Stop-loss and Take-profit levels
A Stop-loss level (SL) is the predetermined price of an asset, set below the current price, at which the position is closed in order to limit an investor's loss on that position. Conversely, a Take-profit (TP) level is a predefined price at which traders close a profitable position.
Instead of using real-time Market orders, traders can set these levels to trigger automatic selling without having to monitor the markets 24/7. Binance Futures, for example, has a Stop-order feature that combines Stop-loss and Take-profit orders. The system determines whether an order is Stop-loss or Take-profit based on the trigger price levels and the last price or benchmark price when the order is placed.
Why use Stop-loss and Take-profit levels?
Apply risk management
The SL and TP levels reflect current market dynamics, and those who know how to correctly identify their optimal values essentially identify favorable trading opportunities and acceptable risk levels. Assessing risk using SL and TP levels can play a crucial role in preserving and growing your portfolio. Not only do you systematically protect your positions by prioritizing less risky trades, but you also prevent the loss of all your funds. Therefore, many traders use SL and TP levels in their risk management strategies.
Prevent Emotional Trading
A person's emotional state at any given moment can greatly affect decision-making, and this is why some traders rely on a predefined strategy to avoid making trading decisions under the influence of stress, fear, greed or other powerful emotions. Learning to identify when to close a position can help you avoid trading on impulse, allowing you to manage your trades strategically, rather than following your hunches.
Calculate the risk/reward ratio
Stop-loss and Take-profit levels are used to calculate the risk/reward ratio of a trade.
The risk/reward ratio is the measure of risk taken in relation to potential rewards. Generally, it is better to enter trades with a lower risk/reward ratio because this means your potential profits outweigh the potential risks.
You can calculate the risk/reward ratio with this formula:
Risk/reward ratio = (Entry price - Stop-loss price) / (Take-profit price - Entry price)
Why use Stop-loss and Take-profit levels?
There are different methods that traders can use to determine optimal Stop-loss and Take-profit levels. These approaches can be used independently or in combination with other methods, but the end goal is always the same: to use existing data to make more informed decisions when closing a position.
Support and resistance levels
Support and resistance are basic concepts familiar to any technical trader in traditional and crypto markets.
Support and resistance levels are areas on a price chart that are more likely to experience increased trading activity, whether buying or selling. At support levels, downtrends may stop due to increasing levels of buying activity. At resistance levels, uptrends may stop due to increasing levels of selling activity.
Traders who use this method generally set their Take-profit level just above the support level and the Stop-loss level just below the resistance level they have identified.
Here is a detailed explanation of the Basics of Support and Resistance Levels.
Moving averages
This technical indicator filters out market noise and smoothes price data to show the direction of a trend.
Moving averages (MA) can be calculated over a shorter or longer time frame, depending on each trader's preferences. Traders monitor moving averages closely, looking for sell or buy opportunities presented in crossover signals, where two different MAs cross on a chart. You can learn more about moving averages here.
Typically, traders using MAs identify stop-loss levels below a longer-term moving average.
Percentage method
Instead of a predefined level calculated using technical indicators, some traders use a fixed percentage to determine SL and TP levels. For example, they can choose to close their position once the price of an asset is 5% higher or lower than the price they entered. This is a simple approach that works well for traders who are not very familiar with technical indicators.
Other indicators
We have mentioned a few common TA tools used to establish SL and TP levels, but traders use many other indicators. This includes the Relative Strength Index (RSI), which is an inertial indicator that signals whether an asset is overbought or oversold, Bollinger Bands (BB), which measure market volatility, and Moving Average Convergence Divergence (MACD). ), which uses exponential moving averages as data points.
To conclude
Many traders and investors use one or more of the above approaches to calculate Stop-loss and Take-profit levels. These levels serve as technical incentives to exit a trade, whether to abandon a losing position or take potential profits. Note that these levels are unique to each trader and do not guarantee success. Rather, they guide decision-making, making it more systematic and robust. Thus, assessing risk by identifying Stop-loss and Take-profit levels or using other risk management strategies is a good trading habit.
