A trader this weekend emailed me a question about the placement of stops and take profit orders.
Please, I have this simple but confusing problem. Where to place my STOP LOSS ORDER AND MY TAKE PROFIT ORDER while making new order both in BUYING AND SELLING PLease explain these to me in your reply.
Here’s the thing. Your exit strategy (stop loss or take profit) should be based on the same strategy you use to enter positions. By that I mean if you are trend trading, then your exits should be based on that. If you are a range trader, then you stops and take profits should be based on that. You generally should not employ a seperately derived strategy for exiting and for entering for the simple reason that you could cause conflicts between the two.
Let me explain that with an example.
Trend trading is an approach which focuses on attempting to identify trends near their beginning, get on, and ride them for as long as they will run. One’s entry strategy attempts to spot newly developing trends. The exit strategy employed should be one which seeks to close a position when that trend has ended. That generally means leaving a position running and not using a target for the simple reason that if one were to employ a target it could result in large profits being missed. Trend trading systems tend to generate the bulk of their returns from a relateively few very large winners. The trader who uses a target would lose those very big winners, probably ruining the performance of the system.
On the other hand, one trading a range system would definitely want to use a target based on the other edge of the range being traded.
As for the placement of stops, my personal view is that a stop should be put at the point where, if reached, the market has told you that the move you were expecting to happen is probably not going to, at least the way you anticipated. I do not use arbitrary fixed stops. Nor do I employ “stop loss” orders. My stop exit is placed on the basis of my overall strategy.
Of course, the best as advice will always be “test, test, test”.
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About the Author
John Forman, author of this blog, has traded for more than 20 years, is a professional market analyst, and authored The Essentials of Trading. He is an active participant in trading forums, consults for trading related businesses, as published literally dozens of trading articles, and has been quoted in a number of books and in the media.
** See John’s full bio.
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