When it comes to financial trading, you would already know or hear terms like stop loss and take profit orders. There are good reasons why these orders are so critical in successful financial trading. Stop loss is an order that closes an open trade when losses hit a certain amount, and taking profit is the opposite of it. But did you know that both stop loss and take profit are the same type of orders? Let’s explain further why you must use stop loss and take profit and how to apply them correctly.
Stop Loss and Take Profit Explained
When trying to develop a profitable trading strategy, traders will inevitably face the challenge of setting strict risk management measures such as stop loss and take profit. Stop loss orders simply prevent traders from losing more than a certain amount. While we won’t stop for details, stop loss explained for beginners will provide all the essential information about the exact mechanisms behind this order type. If stop loss prevents from losing more than a certain amount, take profit is its opposite as it closes the position when in profit for a certain amount of pips. Both of these orders are a central part of any profitable trading strategy and traders must always use them, at least stop loss orders. These orders help traders follow a disciplined, scientific path of financial trading and enable them to restrict emotional trading and maintain consistency. Consistency is critical in financial trading and helps build a habit of healthy trading procedures.
Risk Management in Financial Trading
Risk management is a cornerstone of all successful financial traders. Without proper SL and TP orders, traders expose themselves to unpredictable market conditions and might lose all their money if the volatility is high enough. Here are key reasons why traders should always employ these orders:
- Prevents financial ruin — Without SL order, markets might move violently, which can quickly result in huge losses or even financial ruin by blowing up an account.
- Ensures profitability — TP enables traders to lock in profits without getting too greedy and lose it all.
- Reduces emotional trading — When you automate exit, there is less chance for impulsive decisions.
- Increased trader’s control over their account — By using SL and TP orders, traders control how much they risk for each trade and their potential profit targets before even opening a trade, which is super flexible for collecting important data about their trading performance.
Without risk management, trading becomes gambling and excessive losses are just a matter of time. By using stop loss and take profit, traders take control of their trading results and ensure disciplined trading, which is critical.
Why It Is Impossible to Stay in the Game Without Stop Loss
The game of financial trading requires traders to deploy strict risk management measures, or they might end up losing it all, otherwise. Many traders believe they can manually exit trades without a stop loss, but it might become super risky due to:
- Market volatility — Unexpected news events, economic reports, or flash crashes can cause super rapid price swings and traders might end up losing too much money quickly.
- Delayed reactions — Watching charts 24/7 is impossible and traders might miss the perfect exit points, missing an opportunity to cut losses early.
- Psychological pressure — Holding on to losing trades is a common way of losing money in financial markets, where beginner traders hope for a reversal, which usually leads to even greater losses.
Using stop loss and take profit orders, traders ensure to stay in the game of financial trading by protecting their capital and maintaining a structured approach, which is critical in trading.
When Even Stop Loss Can Not Protect You
Several cases can occur in the financial markets when even stop losses will not be able to stop excessive losses. The number one risk is a gap. The gap is when price movies past the stop loss due to extreme volatility, missing the stop loss. In this scenario, traders might lose more than their stop loss due to rapid movements.
Because of this, traders need to combine wise stop loss with smart position sizing to ensure one bad gap can not blow up their account or damage their trading account so that it becomes difficult to continue trading.
