Brief content

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

Introduction

Market entry timing is a strategy in which investors and traders try to predict future market prices and find the optimal price level for buying or selling assets. With this approach, it is very important to know when to exit the market. This is when stop-loss and take-profit levels come into play.

Stop-loss and take-profit levels are price guides that traders set in advance. These predetermined levels are designed to minimize emotional trading and are necessary for risk management. They are often used as part of an exit strategy by a disciplined trader.

Stop-loss and take-profit are equal

A stop loss level (SL) is a predetermined price of an asset set below the current price at which the position is closed in order to limit the investor's loss on the position. Conversely, a take-profit level (TP) is a set price at which traders close a profitable position.

Instead of using real-time market orders, traders can set these levels to trigger automatic sales without the need to monitor the markets 24/7. Binance Futures, for example, has a stop order function that combines stop-loss and take-profit orders. The system decides whether an order is a stop-loss or a take-profit based on the levels of the trigger price and the last price or mark price when the order was placed.

Why use stop-loss and take-profit levels?

Risk management

SL and TP levels reflect current market dynamics, and whoever knows how to correctly determine their optimal values ​​actually determines favorable trading opportunities and acceptable levels of risk. Risk assessment using SL and TP levels can play a critical role in maintaining and growing your portfolio. Not only do you systematically protect your assets by prioritizing less risky trades, but you also prevent your portfolio from being completely wiped out. Therefore, many traders use SL and TP levels in their risk management strategies.

Preventing emotional trading

A person's emotional state at any given time can greatly affect decision-making, which is why some traders rely on a set strategy to avoid trading under stress, fear, greed or other strong emotions. Knowing when to close a position can help you avoid impulsive trading, allowing you to manage your trades strategically rather than haphazardly.

Calculating the risk-to-reward ratio

Stop-loss and take-profit levels are used to calculate the risk-to-reward ratio of the transaction.

Risk-to-reward ratio is the degree of risk accepted in exchange for potential reward. It is generally better to enter into trades with a lower risk-to-reward ratio, as this means that your potential profits outweigh the potential risks.

You can calculate the risk-to-reward ratio using this formula:

Risk-to-reward ratio = (Entry Price - Stop Loss Price) / (Take Profit Price - Entry Price)

How to calculate stop-loss and take-profit levels

There are various 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 techniques, but the ultimate goal remains the same: to use existing data to make more informed decisions about when to close a position.

Support and resistance levels

Support and resistance are basic concepts familiar to any technical trader in both traditional and cryptocurrency markets.

Support and resistance levels are areas on a price chart that are more likely to see increased trading activity, either buying or selling. The downtrend is expected to stop at support levels due to increased buying activity. And vice versa. The uptrend is expected to stop at resistance levels due to increased selling activity.

Traders who use this method usually set their take profit level just above the support level and their stop loss level just below the resistance level they have identified.

A detailed explanation can be found in the article "The Basics of Support and Resistance".

Moving averages

This technical indicator filters the market noise and smooths the price data to show the direction of the trend.

Moving averages (MAs) can be calculated for a shorter or longer period, depending on the preferences of individual traders. Traders keep a close eye on moving averages, looking for opportunities to sell or buy, presented in crossover signals when two different moving averages cross on a chart. A detailed explanation can be found in the article Moving averages.

As a general rule, traders using MAs set stop-loss levels below the long-term moving average.

Percentage method

Instead of a predetermined level calculated using technical indicators, some traders use a fixed percentage to determine SL and TP levels. For example, they can close their position as soon as the price of the asset becomes 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 determine SL and TP levels, but traders use many other indicators. These include the Relative Strength Index (RSI), which is a momentum indicator and 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.

Results

Many traders and investors use one or a combination of the above approaches to calculate stop-loss and take-profit levels. These levels are technical motives for them to exit the deal: to abandon a loss-making position or to receive a potential profit. Please note that these levels are unique to each trader and do not guarantee success. Instead, they guide the decision-making process, making it more systematic and reliable. Thus, assessing risk by setting stop-loss and take-profit levels or using other risk management strategies is a good trading habit.