Stop loss and take profit levels are two basic concepts that many traders rely on to determine their trade exit strategies depending on how much risk they are willing to take. These thresholds are used in both traditional and cryptocurrency markets, and are especially popular among traders who prefer technical analysis.

introduction

Market timing is a strategy in which investors and traders attempt to predict future market prices and find the optimal price level to buy or sell assets. Under this approach, determining when to exit the market is vital. This is where stop loss and take profit levels come into play. 

Stop loss and take profit levels are price targets that traders set for themselves in advance. Often used as part of a disciplined trader's exit strategy, these pre-determined levels are designed to keep emotional trading to a minimum and are essential for risk management.

Stop loss and take profit levels

A stop loss level (SL) is a pre-determined price of an asset, set below the current price, at which a position is closed in order to limit the investor's loss on that position. Conversely, a take profit (TP) level is a predetermined price at which traders close a profitable position.

Instead of using real-time market orders, traders can adjust these levels to trigger automatic selling without having to monitor the markets 24/7. For example, Binance Futures has a stop order function that combines stop loss and take profit orders. The system decides whether the order is a stop loss or take profit based on the levels of the strike price and the last price or tick price when the order was placed. 

Why do we use stop loss and take profit levels?

Practice risk management

Stop Loss and Take Profit levels reflect current market dynamics, and those who know how to correctly define their ideal values ​​essentially determine favorable trading opportunities and acceptable risk levels. Assessing risk using stop loss and take profit levels can play a crucial role in maintaining and growing your portfolio. Not only do you systematically protect your holdings by prioritizing lower-risk trades, but you also prevent your entire portfolio from being wiped out. Therefore, many traders use stop loss and take profit levels in their risk management strategies.

Prevent emotional trading

A person's emotional state at any given moment can greatly influence their decision-making process, which is why some traders rely on a predetermined strategy to avoid trading under pressure, fear, greed, or other strong emotions. Learning how to determine when to close a position can help you avoid trading impulsively, allowing you to manage your trades strategically rather than erratically.  

Calculate the risk to reward ratio

Stop loss and take profit levels are used to calculate the risk to reward ratio of a trade.

The risk-reward ratio is a measure of the risk taken versus the potential rewards. In general, it is better to enter into trades with a lower risk-reward ratio, because that means your potential profits outweigh the potential risks. 

You can calculate your risk to reward ratio using this formula:

Risk to reward ratio = (entry price - stop loss price) / (take profit price - entry price)

How to calculate stop loss and take profit levels

There are different methods that traders can use to determine optimal stop loss and take profit levels. These methods can be used independently or in combination with other methods, but the ultimate goal remains the same: to use existing data to make more informed decisions about when to close a position.

Support and resistance levels

Support and resistance are basic concepts familiar to any technical trader in both traditional and cryptocurrency markets. 

Support and resistance levels are areas on a price chart that are likely to see an increase in trading activity, whether that is buying or selling. At support levels, downtrends are expected to pause due to increased levels of buying activity. At resistance levels, upward trends are expected to pause due to increasing levels of selling activity.

Traders using this method typically set a take profit level just above the support level and a stop loss level just below the resistance level they have identified.

Below is a detailed explanation of the basics of support and resistance.

Moving averages

This technical indicator filters out market noise and smoothes price action data to display trend direction. 

Moving Averages (MA) can be calculated over a shorter or longer period, depending on the preferences of individual traders. Traders watch moving averages closely, looking for buy or sell opportunities presented in crossover signals, where two different moving averages intersect on a chart. You can read about moving averages in detail.

Typically, traders who use moving averages set stop-loss levels below the longer-term moving average. 

Percentage method

Instead of a predetermined level calculated using technical indicators, some traders use a fixed percentage to set stop loss and take profit levels. For example, they may choose to close their position once the price of the asset is 5% higher or lower than the price they entered. This is a straightforward approach that works well for traders who are not familiar with technical indicators.

Other indicators

We've mentioned some common technical analysis tools used to determine stop loss and take profit levels, but traders use many other indicators. These include the Relative Strength Index (RSI), a momentum indicator that indicates whether an asset is overbought or oversold, the Bollinger Bands (BB), which measures market volatility, and the Moving Average Convergence Divergence (MACD), which It uses exponential moving averages as an indicator. Data points.

Closing thoughts

Many traders and investors use one or a combination of the above methods to calculate stop loss and take profit levels. These levels act as technical drivers for them to exit a trade, whether it is to unwind a losing position or realize potential profits. Note that these levels are unique for each trader and do not guarantee successful performance.  Instead, they guide the decision-making process, making it more systematic and robust. Therefore, assessing risk by setting stop loss and take profit levels or using other risk management strategies is a good trading habit