Trading Strategy

How to Correctly Place Take Profit Order in a Trade?

December 26, 2021 | 4:13 pm | The 5%ers' Blog > Trading Strategy
December 26, 2021 | 4:13 pm
The 5%ers' Blog > Trading Strategy
How to Correctly Place Take Profit Order in a Trade?

Take profit order

If you are new to trading, it’s very important to know how to profitably get out from a trade.

Every trade you place requires an exit. But the whole point of trading is to exit the trade with profit.

So, how can you exit the trade successfully? You can do it through the take-profit order target.

This guide talks about what take-profit order is and how to place it correctly.

 

What is take-profit order?

A take-profit order, denoted as TP, is a type of order that mentions the specific price at which you should close an open position for profit. 

If the forex pair’s price does not reach the specific price, the take-profit order is not hit.

When prices begin to climb, these orders function as a ceiling, ensuring you can sell forex pairs before values fall again. 

It’s similar to knowing when to leave the table when playing poker. But, instead of continuing and risking leaving with less, you conclude on a good note.

For example, if you are long GBP/USD at 1.34192 and want to profit when the price reaches 1.3830, you will select this as your take-profit level.

If the bid price reaches 1.3900, the open trade is automatically closed, resulting in a profit of 70 pips.

The GBP/USD chart below illustrates the take-profit order:

GBP/USD take-profit illustration

 

Most traders employ take-profit orders combined with stop-loss orders to manage their open positions. If the currency pair climbs to the take-profit level, the TP order is executed, and the position is profitable.

If the currency pair goes below the stop-loss level, the stop-loss hits, and the position closes on a loss. The difference between the market price and take-profit and stop-loss serves to determine the risk/reward ratio of the trade.

 

How to correctly set a take-profit?

Before moving to set take-profit orders, let’s discuss a few considerations. 

When deciding on a take-profit level for your trading strategy, keep in mind that it can be triggered by a range of market fluctuations and is not always predictable. It is possible for price to randomly contact TP independent of the direction you opened the position. Your trading strategy and risk tolerance will always determine how you set your take profit. You can set a low TP to provide for more secure trade. But, on the contrary, you may be more flexible with your take-profit, providing greater flexibility in a more unpredictable market.

Now let’s move to set a take-profit order. 

Setting TP is an art; you want to maximize your earning potential based on the characteristics of the market you’re trading in.

But you can’t be too greedy, or the price will fall short of your target. As a result, you don’t want it to be too close or too far away.

One of the simplest approaches for calculating a profit objective is to use a preset reward: risk ratio. Your entry point will determine your stop loss amount. This stop-loss specifies how much money you are willing to risk on the deal. Profit is calculated as a multiple of this, such as 1:3.

Risk/Reward ratio of 1:3

For example, if you buy a currency pair at 1.2500 and set a stop loss at 1.2400, you risk 100 pips on the trade.

If you choose a reward-to-risk ratio of 1:2, your profit target should be set at 1.2700, 200 pips from your entry point (100 pips x 2).

Fixed targets assure that you make more money on winners than you lose on losses, but they ignore the current market situation or price action patterns. As a result, predefined targets become very erratic. It is, however, a wonderful approach, provided you have a solid entry method and a well-placed stop loss.

Typical reward/risk ratios in short-term trading vary between 1:1.5 and 1:3. Try on a demo account with the market you’re trading to discover whether a 1:1.5 or 1:2 reward-to-risk ratio works better with your particular entry method.

 

Why should you trade with take-profit order?

While we can never predict which trades will be winners and losers before we enter them, we are more likely to make an overall profit if our winning trades outnumber our losing trades throughout several trades.

For example, if we day trade forex and our winning trades average 11 pips while our losing trades average six pips, we only need to win roughly 40% of our trades to make a profit overall.

Trading with a profit objective allows you to determine whether a trade is worthwhile. Avoid the trade if the profit potential does not outweigh the risk. Setting a profit objective helps to weed out bad trades in this way.

 

Take profit advantages

The advantage of using a take-profit order is that the trader is not required to manually execute a trade or second-guess oneself. On the other hand, take-profit orders are executed at the best available price independent of the underlying forex pair’s behavior.

Short-term traders should apply for take-profit orders. This is because they may exit a transaction as soon as their profit aim is met, avoiding the danger of a future market drop.

If based on systematic and logical analysis, TPs can help remove some of the emotion in trading since the traders know their profit target is in a favorable definition on the chart they are reviewing.

 

Take profit disadvantages

TP may not get hit after all. Instead, the price may climb, approaching the profit objective before reversing direction and reaching the stop loss.

If your profit objectives are set too widely apart, you will most certainly lose a lot of trades. But, on the other hand, if they are too close together, you will not be rewarded for the risk you are taking.

Take-profit orders are not good for long-term trading, as you can’t determine if the price will hit the target in the long run. 

 

Bottom line

Take-profit orders define your trading risk management. They are part and parcel of your trading strategies. Therefore, it’s important to know how to set take-profit correctly before jumping into the trade.

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