Summary

Stop loss and take profit levels are two fundamental concepts that many traders rely on to establish their exit strategies for a trade based on how much risk they are willing to take. These thresholds are used in both the traditional and cryptocurrency markets, and are especially popular among traders who prefer a technical analysis approach.

Introduction

Market gauging is a strategy in which investors and traders try to predict future market prices and find an ideal price level to buy or sell assets. If using this approach, it is essential to discover when is the best time to exit the market. To elucidate this, the stop loss and take profit levels come into play.

Stop loss and take profit levels are price targets that traders set for themselves in advance. Often used as part of a disciplined exit strategy: these predetermined levels are designed to minimize emotional trading and are essential for risk management.

Niveles stop loss y take profit

A stop loss level (SL) is the preset price of an asset, marked below the current price, and determines where a position will be closed in order to limit the investor's loss on that position. In contrast, a take profit (TP) level is a pre-set price at which traders choose to 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 decides whether an order is a stop loss or take profit based on the trigger price levels and the last price or mark price when the order is entered.

Why is it good to use stop loss and take profit levels?

To exercise risk management

The SL and TP levels reflect the current market dynamics. Those who know how to correctly identify these optimal values ​​will basically be identifying favorable trading opportunities and acceptable risk levels. Assessing risk using SL and TP levels can play a critical role in preserving and growing your investment portfolio. Not only will you be systematically protecting your holdings by prioritizing trades with less risk, but you will also be preventing your portfolio from disappearing completely. It is for this reason that many traders use SL and TP levels in their risk management strategies.

To avoid emotional trading

The emotional state can, at a certain moment, greatly affect decision making. Therefore, some traders rely on a pre-established strategy to avoid carrying out their trading activity under stress, fear, excessive ambition or other powerful emotions. Learning to identify when is the best time to close a position can help you avoid impulsive trading, allowing you to manage your trades strategically rather than spontaneously.

To 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 assumed in exchange for potential rewards. It is generally better to open trades with a lower risk-reward ratio, as this means that the profit potential outweighs the possible risks.

You can calculate the risk-reward ratio with this formula:

Risk-reward ratio = (entry price - stop loss price) ÷ (take profit price - entry price)

How to calculate stop loss and take profit levels

Traders can use several methods to determine ideal stop loss and take profit levels. These approaches can be used alone or in combination with other methods, but the ultimate goal remains the same: use existing data to make informed decisions about when to close a position.

Support and resistance levels

Support and resistance are core concepts that technical traders know, both in the traditional and cryptocurrency markets.

Support and resistance levels are areas on a price chart that have a higher probability of experiencing increased trading activity, whether buying or selling. At support levels, the downtrends are expected to be interrupted due to the increasing level of buying activity. At resistance levels, the bullish trends are expected to be interrupted due to the increasing level of selling activity.

Traders using this method typically set their take profit level just above the support level and their stop loss level immediately below the resistance level they have identified.

We provide you with a detailed explanation of the Basics of Support and Resistance.

Moving averages

This technical indicator filters out market noise and optimizes price action data to indicate the direction of a trend.

Moving Averages (MA) can be calculated over short or long time periods, depending on each trader's preferences. Traders monitor moving averages closely for opportunities to sell or buy that occur in crossover signals, or when two different moving averages intersect on a chart. Read more about moving averages in detail.

Typically, traders using moving averages identify stop loss levels below a longer-term moving average.

Percentage method

Instead of using a preset 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% above or below the price entered. This is a simple approach that works well for traders who are not fluent in technical indicators.

Other indicators

We mentioned some technical analysis tools that are commonly used to establish SL and TP levels, but traders also use many other indicators. For example, the Relative Strength Index (RSI), which is a momentum indicator that signals whether an asset is overbought or oversold; Bollinger Bands (BB), which measure market volatility; and the Moving Average Convergence/Divergence (MACD), which uses exponential moving averages as data points.

Conclusions

Many traders and investors use one approach or a combination of them to calculate stop loss and take profit levels. These levels serve as technical motivations to exit a trade, either by abandoning a losing position or realizing potential profits. Please note that these levels are unique to each trader and do not represent a guarantee of successful performance. Instead, they guide decision-making to make it more systematic and robust. Therefore, assessing risk by identifying stop loss and take profit levels, or by using other risk management strategies, is a good trading habit.