A trade has three prices decided before it begins: where you get in, where you get out if you are right, and where you get out if you are wrong. Deciding all three in advance is what separates a trade from a guess.
Entry
The entry is the price at which your position opens. You can enter at market, or place a limit or stop order and wait, as covered in Topic 5.
Beginners concentrate almost entirely on entries, because that is where most content concentrates. Entry is just one element of a good trade. An average entry with a sensible exit plan will survive, while an excellent entry with no exit plan eventually will not.
Stop loss
A stop loss is an order that closes your position automatically at a set level of loss.
Go long at 5000 with a stop at 4980, and your position closes if price reaches 4980, losing 20 points multiplied by your position size.
What it does for you:
- Converts an unknown loss into a known one, before you take the trade
- Removes the decision from the moment you are least capable of making it, which is while losing money
- Provides the input that lets you calculate position size, covered in Topic 7
A stop loss does not guarantee the exact price. It becomes a market order when triggered, so in fast conditions or over a weekend gap you can be filled worse than your stop level. Some brokers offer a guaranteed stop for an extra fee, which does remove that risk.
Take profit
A take profit is an order that closes your position automatically at a set level of gain.
Go long at 5000 with a take profit at 5060, and the position closes with 60 points of gain if price reaches it.
Setting one in advance means deciding, while calm, what a reasonable outcome looks like. The alternative is deciding while the position is open and your judgement is distorted by money moving in front of you.
Risk to reward
Compare the distance to your stop with the distance to your take profit and you get the risk to reward ratio of the trade.
Risk 20 points to make 60, and the ratio is 1:3.
This ratio and your win rate, meaning the percentage of trades that win, together determine whether a method makes money. A method winning 30 percent of the time at 1:3 is profitable. A method winning 70 percent of the time at 1:0.3 is not. Beginners usually chase a high win rate, which on its own is the wrong variable to optimise.
The full treatment, including expectancy, is in the Risk Management guide.
Managing a trade once it is open
Options you will hear discussed:
- Moving to breakeven: shifting the stop to your entry price once the trade has moved in your favour, so the trade can no longer lose
- Trailing stop: moving the stop along behind price as it advances, locking in progress
- Partial close: closing part of the position at a target and leaving the rest running
Each carries a cost. Moving a stop too early converts winning trades into scratches. No setting is correct in all conditions, which is why this belongs to the method you build rather than to a rule someone hands you.
Widening a stop because price is approaching it is the one adjustment with no defence. It takes a loss you had planned for and makes it open-ended.
Key terms
- Entry: the price at which a position opens
- Stop loss: an order closing the position at a set loss
- Take profit: an order closing the position at a set gain
- Risk to reward: the ratio of the distance to stop against the distance to target
- Breakeven: a stop moved to the entry price
- Trailing stop: a stop that follows price as it moves in your favour