What is Stop-Loss and Take-Profit: calculation and use on Forex

Trading on the financial market is associated with high risk due to rapid fluctuations in asset prices. Many traders, unfortunately, do not manage to strictly follow the rules of money management, which they read about in training materials. As a result, trades are often opened for a significant part of the deposit.

Nevertheless, traders usually adhere to risk management by setting Stop-Loss and Take-Profit levels for each trade. These tools are available for free on all trading platforms.

What is Stop-Loss and Take-Profit?

Take-Profit is the level at which a trade is automatically closed, locking in profit. Stop-Loss, on the contrary, is designed to minimize losses by automatically closing a deal when it reaches a specified level.

These tools protect the trader from large losses. However, it should be taken into account that in rare cases slippages may occur, in which it is impossible to close the position at the specified price.

Setting Stop Loss and Take Profit levels

Initially, setting these levels may seem like a simple task. However, to determine the optimal levels, you need to analyze the dynamics of asset prices and take into account many nuances.

Some traders set stop loss and take profit only at the beginning of their career. However, it is important to remember that even with constant monitoring of the chart, the situation can change instantly, turning a profit into a loss.

Stop loss operation

A stop-loss is an order to the broker to close a position when it reaches a certain level. It remains active even without your participation, automatically closing the position if the price goes against you.

There are three main types of stop losses:

  1. Percentage Stop – based on a percentage of the trade amount.
  2. Chart Stop – based on technical analysis.
  3. Volatility Stop – takes into account the volatility of the market.

Take Profit work

Take Profit is an order to the broker to close a deal when a certain profit level is reached. It helps to fix the profit, preventing its loss when the market situation changes.

Calculation of Stop Loss and Take Profit

Traders have access to free online calculators on brokers’ websites to calculate these levels. It is important to determine the size of the potential loss and profit, as well as calculate the change in balance when the price changes by one point.

Calculation example

Suppose you open a position to buy one lot of USDCHF at the price of 1.6815, with the target levels of Take Profit $120 and Stop Loss $60. To calculate the pip value, multiply the lot by the price step and divide by the current rate:

Cost per pip = (100,000 x 0.0001) / 1.6815 = 5.95 USD

By setting take profit at 20 pips from the current price, your profit will be $119. A stop loss of 10 pips from the current price will result in a loss of $59.5.

Setting levels in MetaTrader 4

To set stop loss and take profit:

  1. Open MetaTrader 4.
  2. Click “New Order”.
  3. Select the asset, position volume and execution type.
  4. Enter the Stop Loss and Take Profit values.
  5. After opening a position, go to the “Trade” tab, right-click on the position and select “Modify or Delete Order”.

Conclusion

Stop loss and take profit are key risk management tools. It is important that their setting is in line with your strategy and technical analysis. Even if you are confident in the forecast, it is better to reinsure yourself and protect your deposit.

Emotions can be a trader’s enemy, and using these tools helps to preserve capital in unpredictable situations.

What is a spread in the financial markets?

Any trader or investor comes to the financial markets with the purpose of making money. He or she seeks to buy assets cheaper and sell them more expensive, capitalizing on the price difference between the associated commodities and expected market movements.

In any case, the trader analyzes the price and its fluctuations between sellers and buyers, which in financial markets is called a spread.

Let’s take a look at what a currency spread is and what other types of price ranges exist on exchanges.

What is a spread

In the financial context, the concept of “spread” (from the word “spread” – divergence) can differ depending on the type of asset. In general terms, a spread is the difference between two price values for the same or similar instruments.

For example, it can be the range between:

  • The prices of sellers and buyers in the market at a given moment.
  • Prices for one asset: currency, stocks, futures at the current moment and after a certain period of time.
  • Prices for the same type of commodity, but of different brands, etc.

The most common variant in trading and investing is the difference between the bid and ask price (Bid – Ask). This is a commission for each transaction, which makes up the broker’s profit.

This is how, for example, the currency spread is formed. The exchange glass helps to better understand this concept. It is a special table formed by a market maker, where all limit orders from sellers and buyers of an asset are reflected. Bids are placed depending on their proximity to the current quote: the closer supply and demand are to the current price, the smaller the currency spread is. Since orders on active pairs are quickly satisfied and removed from the stack, the spread is constantly changing.

The spread for CFDs on shares and other securities is formed in a similar way. It can be several dollars, cents or even a fraction of a cent, so it is usually denoted in points. For example, if the price of NASDAQ 100 index is 11760.5/11761.3, the spread will be 8 cents or 8 points. This value is displayed in the market overview and in the glass.

It is believed that the smaller the spread, i.e. the closer the price of buyers and sellers, the more liquid the asset. This means that a trader is highly likely to be able to buy or sell it at the right time at an adequate price.

Types of spreads

Depending on the type of exchange-traded or OTC asset, the concept of “spread” can vary.

Currency spread

If we talk about the spread as a difference between bid and ask prices, as in the case of currency pairs or CFDs, it can be divided into fixed and floating spreads.

A fixed spread does not change regardless of market conditions: even when important news is released, when supply and demand shifts sharply. This level is set and maintained by the broker. It is usually higher than the standard floating spread in a calm market and lower in times of increased volatility. Today fixed spreads are rare, they have been replaced by market spreads.

A floating or market spread depends on supply and demand in the exchange stack and changes according to the preferences of traders. Usually for volatile assets it is more favorable than the fixed one and can be equal to zero at times. However, at the moments of important news release such a spread logically widens, so many brokers warn their clients about it.

Market spreads

There are intermarket and intramarket price ranges.

Intermarket spread reflects the difference in the cost of the selected asset on different exchanges, which is typical for securities. An intra-market spread is the difference between highly correlated or related instruments, for example, between stocks and their ADRs.

A special type of intra-market spread is the calendar spread, which exists in the derivatives market. It shows the difference in the prices of contracts for the same asset with different expiry dates.

Futures spread

This type of spread represents a trading strategy. Unlike a currency spread, a futures spread is a method in which a trader simultaneously buys and sells contracts on identical or similar commodities to profit from the divergence of their prices.

A futures spread occurs when:

  • Buying and selling a contract for the same asset with delivery in different months.
  • Buying and selling futures on different assets with similar quotation dynamics (correlation).
  • Buying and selling contracts for the same commodity of different quality.

Factors affecting the spread size

The size of the currency spread and similar spreads is influenced by various factors relating to a particular financial instrument. The main ones are:

  • Liquidity of currencies and securities: The higher the liquidity, the lower the spread. A large number of traders and market participants interested in transactions with this instrument leads to an increase in buy and sell orders and increases the chances of quickly concluding a deal at the right price.
  • Volume of trades and transactions: On stock exchanges, large transactions lead to a widening of the spread as many limit orders are executed at the same price.
  • Transaction amount: If an asset is purchased for a very small or very large amount, there are additional brokerage fees that increase the commission.
  • News and Publications: The main drivers of markets. Buy or sell decisions are often made based on them. After news releases, demand or supply increases sharply, causing the spread to widen. Before important news, trading activity drops, liquidity decreases and the spread widens.

How to work with the spread

It is impossible to artificially influence the stock or currency spread, as it depends on market conditions. But in order to reduce costs, you can:

  • Do not trade at times of low liquidity and the release of important news.
  • Open accounts with floating spread and choose active trading hours.
  • Choose popular currency pairs and securities.

Spread is less important for long-term strategies, but in this case you should take into account another parameter – swap (if it is applied).

Opening positions with limit orders can significantly reduce risks and additional costs, especially for large transactions or work with unpopular assets.