How to place your stop loss and profit target correctly?
Stop loss
I have decided to start my forex tips lessons with this topic because capital preservation is the most important aspect of forex trading and you can’t preserve your capital unless you know how to set your stop loss correctly.
Placing your stop losses incorectly will lead either to exiting a trade prematurely and missing a good oportunity or exiting too late and suffering big losses.
Did it ever happened to you to enter a trade and the market going against you, hitting your stop loss only to discover shortly afterwards that the market reverted and went in the direction you initially anticipated? You don’t have to answer this question, if you traded the forex market for at least a month, you’ve surely experienced this frustrating situation.
So what do you do when you get trades like these? The vast majority of beginners in forex trading, immediately assume that their stop losses are too tight so they start using larger stop losses to “let the trade breathe”.
Is this the answer? Absolutely NOT! Than where is the mistake? The mistake lies in the aproach many newbies are using when placing their stop loss.
Unexperienced forex traders are entering trades using predetermined stop losses and profit targets (like 30 pips SL and 60 pips PT or 20/40) that have nothing to do with the reality of the market.
First you should never trade on impuls. All your trades must be well planned in advance. You enter the market only when your plan generates a trading signal and at that moment you should know exactly where to place your stop loss and profit target.
Your stop loss should be placed where the market tells you. Take a look at the charts and search for areas of support/resistance, draw trendlines, use fibonacci retracements and pivot points. You should place your stop loss in a point of inflection, If that level is breached it means you were wrong on the direction of the market and your trade is no longer valid.
Of course this is no holy grail, you will still have loosing trades but placing your stop loss correctly will definitely improove your trading results.
Profit target
Same story goes for determining profit targets. Analyze your charts! Is it a range trading market or is it a trending market? In a range trading market if you are short you should place your target profit near support (a few pips before). If you’re in a trending market use leading indicators like fibonacci extension theory and pivot points theory.
Fibonacci extensions
Fibonacci extensions are used to predict where the market will go after a retracement assuming it continues in its original direction. The dipper the market retraces the smaller the extension will be.
The theory says that a 38.2% retracement predicts 161.8% and beyond extension, a 50% retracemnts predicts 138.2% to 161.8% extension, a 61.8% retracement predicts 121.4% to 138.2% extension and finally a 78.6% retracement predicts 100% to 121.4% extension. If all these make your head spin the example bellow will clarify everything.
Calculation of pivot points
PP =(HIGH + LOW + CLOSE)/3
S1 =(2*PP) – HIGH
S2 = PP – RANGE
S3 = S2 – RANGE
R1 = (2*PP) – LOW
R2 = PP + RANGE
R3 = R2 + RANGE
M-lines (midpoints between support and resistance pivots)
M4 is the middle of R2 and R1
M3 is the middle of PP and R1
M2 is the middle of PP and S1
M1 is the middle of S2 and S1
Pivot points can also be used to predict an extension after a rejection near a pivot level.
S1 rejection points to R1 extension
M1 points to M3
M2 points to M4
Find a confluence between these 2 theories and there’s you’re profit target.
I’ve learned all about these target extension theories from Wayne McDonell. You can visit his website here. I also recommend you his book “The FX Bootcamp Guide to Strategic and Tactical Forex Trading” – best forex book i’ve ever read.
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Tags: profit target, stop loss
