Take Profit and Stop Loss in Trading (Etoro usually)

The information and opinions in this post are not intended to be investment advice. Seek a duly licensed professional for investment advice.

So, whenever you make a trade, you're obviously hoping to make a profit. That's pretty obvious. A 'Take Profit' and a 'Stop Loss' are two little things you can set when you open a new trade, and they're both ways to predetermine conditions for when you want that trade to close. They're both there to protect your wealth basically.

You can close a trade whenever you want, as long as you're watching...

Now, you can always close a trade manually. Whenever you want, if you think "Yeah, that's a good amount of profit, I want to close this trade..." you can. You just click the right button, close the trade manually, and you're out, with all that nice profit to go and play with. Conversely, your trade may be losing money, you may not think that the asset will recover ,and start making you money, so you think "O.K, that's enough, I don't want to lose anymore, I'm going to close this, cut my losses, and get out of it - I can use the money for better things..." and you can - you can just close the trade manually and stop losing any more of your hard-earned cash.

What happens if you're not watching the live prices?

Both of those scenarios above only happen when you're actually watching the asset's price. You're sitting at your computer, watching the real-time price, and either you decide to get out, because you've made enough, or you decide to get out because you've lost enough. But you can't always be sitting at your computer. You need to sleep. You may even want to go outside sometimes and have 'a life'... So what do you do?

This is where the 'Take Profit' and the 'Stop Loss' become useful.

Take Profit

A Take profit is a predetermined price or percentage of profit that you specify, at which you want the system to automatically close the trade, as you've made as much profit as you want to, or think you can... So, when you open the trade (you can also adjust it whilst the trade is open) you can go to the 'Take Profit' section, and set either the percentage of profit you'd like to make, or enter specific price target you have for your asset. If that target (or the closest number above it) is ever reached by your asset, you're instructing the system to automatically close your trade, and take those profits, so they'll be there in your available balance to do whatever you want with.

Stop Loss

A 'Stop Loss' will let you sleep at night, or actually leave your computer sometimes and go outside. It deals with how much money you're willing to lose before the system automatically closes the trade for you and returns what's left of your money to your available balance. It's like having a person constantly watching your screen for you - watching the real-time value of your assets. You set it when you open a new trade, and again, you can adjust it whilst the trade is still live. It's a predetermined price, or percentage of loss which you enter, and which, if it is ever reached (or the closest number below it), means that the system will automatically close your trade for you, and ensure no more is lost on that trade. It's a kill-switch to prevent too much loss.

So, a take profit can automatically exit a trade for you when you make a certain amount of profit. A Stop loss can automatically exit a trade for you when you make a certain amount of loss.

Here's a video I made about it:

Here's my profile on the trading site I use (It's my affiliate link, so I get a bonus if you sign up through me :) ) http://etoro.tw/2rcYYm0

So, when might this not work?

The trading platform is constantly linked to the live markets. That's how it knows what the current price of everything is, and lets you buy and sell, and hopefully make money. By 'Markets', I mean the exchanges around the world which assets are traded on. In America, you've got the NASDAQ exchange, and in London, you've got the London Stock Exchange (LSE). There are different major exchanges throughout Europe and Asia too. Some assets, like commodities (Gold, Silver, Platinum etc) are traded around the world on many exchanges. Most equities (stocks and shares) though, have a home exchange - a company is 'Listed' on the NASDAQ, or 'listed' in Frankfurt, or 'listed' on the London Stock Exchange. That exchange is basically their home exchange, and that home exchange needs to be open in order to buy or sell that asset. I always assumed that stocks (really known as equities) could be bought or sold whenever you want - that it was a 24 hour / 7 days a week type of situation. It's not.

When are exchanges open?

Usually, they work like most other businesses - a certain amount of hours per day (usually between 6.5 and 8.5 hours per day depending on the exchange) and a certain amount of days per week (usually 5) (you can easily find their current opening times online.)

How can this effect your stop loss?

In order to close a trade, the market which that asset is 'listed' on needs to be open. So, let's say today, the markets close and your asset is doing fine - it's made a small profit and you're feeling pretty secure. You bought it at $100, and it's now worth $120. You have one unit of the asset, so you've made $20. Nice. Your stop loss is set at $90, so you're safe. But, overnight, something terrible happens - a major event happens which is very bad news for your asset. It could be a scandal in the company, or a geopolitical event like a war causing problems with transportation of your asset, or an economic bit of news like a new competing product has been discovered, or a political event - like a country changing a law which affects imports or taxation on your asset. Or a bad earnings report... The thing is, there are ways to trade 'Outside of market hours' which most retail trading platforms (ones you, and me, and other non professional traders) don't have access to. They call it 'pre-market' trading and 'after hours or 'after market' trading. Trading volume during these sessions is normally extremely low compared to when the markets are actually open. People usually wait until the markets are open to buy and sell assets. If the news is significant enough though, the trading volume during these out-of-hours times can skyrocket, and the price of an asset can change dramatically overnight.

How this can mess up your stop loss

So, let's say, overnight, the price of your asset falls sharply. On your exchange, the price is still reading yesterday's 'closing' price - the last price listed before the market closed for the night, yesterday. You still see the asset listed at $120. But it's not - the real price is now $70. But since your trading platform can only close the trade once the markets open, and it is reconnected to the live markets, it just sits there unchanged. As soon as the markets open, the price on your exchange updates. You've already got your stop loss set at $90, so your platform says "O.K, well he's lost even more than he wanted to, so we better close this trade for him now, and get out of it..." and boom, your stop loss closes your trade automatically and the loss has exceeded your stop loss. Your sale price for the asset was the price which the markets opened at. This can also happen with your Take Profit too - much to your advantage. Overnight, the price of your asset could have changed dramatically upwards due to favourable news, and when the markets open, the system sees that you set your take profit at $160, but now the actual market price is $220, so it thinks "well, it's exceeded his take profit - I'll close that trade for him now..." and boooom, you've made even more than you'd hoped for with your take profit.

A Stop Loss aims for the price you've set, but will trigger at the first number it sees lower than your stop loss, if the price of the asset is lower than your stop loss number when the market opens.

A Take profit aims for the price you've set, but will trigger at the first number it sees higher than your take profit, if the price of the asset is higher than your take profit number when the market opens.

This scenario, where the price suddenly either jumps up, or plummets down overnight is known as "Gapping up" or "Gapping down" respectively, as it refers to the gap in price data for the asset between the close of one day's trading and the opening of the next day's trading.

Trailing stop Loss - A flexible safety net

Whilst you normally set a stop loss at a specific price, or a specific percentage of your trade's initial value, there's another tool called a 'Trailing Stop Loss' which you can use to secure profits whilst still keeping an active safety net in place. This type of stop loss moves in line with your profits on any given trade.

Let's say you buy an asset on Monday at $100. You set your stop loss at $90 (you're willing to risk $10) and set your Take Profit at $300 (if the asset ever reaches a value of $300, you want to automatically close the trade and take your profits of $200). You then take a short break and leave your computer for a few days. When you come back, you see that by Tuesday evening, your asset was valued at $280, but it didn't reach your take profit level, so the trade stayed open. Now, it's Wednesday evening, and the price has dropped back down sharply and is now at $130. Neither your Take Profit, or your Stop Loss has been triggered, but somehow you still feel you've missed out on some profits and could have made more had you been watching.

A Trailing stop loss could have been used in this example to secure a better amount of profit. A trailing stop loss basically follows your profit upwards. It says "Let's keep this trade open, and let the profits run upwards, but, if at any time, the price dips by $10, then close the trade automatically and take my profits for me..."

An example of how a trailing stop loss might work:

So we open a trade at a price of $100. We set our take profit at $300, and we set a Trailing stop loss of $10.

The price starts at $100, and after an hour it's at $130, then, an hour later it has dropped by $5 - to $125, the trade is kept open. It keeps dropping, and reaches $123... It's still open. It starts to climb again and the next day, it's valued at $240, then drops again to $236 - it stays open. It goes up to $280 - it still hasn't reached our $300 Take Profit price, so it stays open. It drops suddenly, and reaches $270 - at this point the trailing stop loss is triggered and the trade is closed at $270, and the profits returned to your account as 'available' funds.

If we had set a standard stop loss, the $10 stop loss would only have been triggered had the price reached $90. But, since we set a trailing stop loss, the stop loss moved upwards as our profits moved upwards, and only triggered the first time the price dropped by $10 during the life of the trade.

Problems with a trailing stop loss

The markets never move either upwards or downwards in a straight line - they're always fluctuating upwards and downwards, whilst following either a general upwards or downwards trend. If the asset is going up in price over time, you'll most likely see a spiky up and down line which overall is going upwards, but with many surges and pull-backs along the way. The same is true for an asset with a falling price, although falling assets tend to fall more sharply downwards than climbing assets move upwards. Due to this up and down rollercoaster type of movement, if you set a very tight stop loss (where the stop loss is set quite close to the current price), then these natural ups and downs of the market may very well trigger your stop loss even though, overall, the asset's value is going in the direction you want. It's a delicate balance to strike, and familiarity with the type of asset you're trading will help inform how "wide" (far away from the initial price of the asset) you set your trailing stop loss. It's no use setting a stop loss which will just be triggered by the ebb and flow of the normal market conditions, as every new trade carries with it a small charge known as a spread fee, so the fewer trades you have to make to reach the same profit, the better.

Over time, I've become a bit more familiar with how to use the Stop Loss and the Take Profit - It's been trial and error, but it's making more sense now. They're really quite useful. Especially the stop loss... Without it, leaving the computer would be a much scarier proposition.

Disclaimer : I'm a noob still, so please learn about and study these things yourself before trading at all - I'm not a pro, just someone passing on his little and undoubtedly incomplete knowledge....

The information and opinions in this post are not intended to be investment advice. Seek a duly licensed professional for investment advice.

Here's my affiliate link to my trading profile again :) http://etoro.tw/2rcYYm0