One of the key skills to master as a crypto trader is risk management. Setting stop-loss and take-profit levels is one facet of risk management all traders can utilise. In this article, we break down how stop-loss and take-profit levels are used to manage crypto trading risks.
- Setting stop losses and take profits after entering a trade serves to define a maximum loss and profit target. Stop losses limit downside risk, while take profits lock in gains.
- Determining stop-loss and take-profit levels is based on price percentages, technical indicators (like moving averages), support and resistance levels, and risk-reward ratios.
- Actively manage stop-loss and take-profit orders by adjusting levels throughout the trade’s lifespan, as executing the orders when prices are hit is paramount in using this strategy.
The Importance of Stop-Loss and Take-Profit Levels in Trading
Setting appropriate stop-loss and take-profit levels is an essential component of risk management when trading. These risk management tools help traders cut losses short when trades move against them and lock in profits when trades move in favour. In this article, we generally take the view of a trader who is ‘long’ (i.e., bought a crypto token), as opposed to ‘short’. Below are the basics of how to set stop-loss and take-profit levels effectively.
A stop-loss order (also known as a ‘stop loss’) is placed with an exchange (or trading platform) to sell a crypto token when it hits a certain price point. This is designed to limit the loss on a position. A stop-loss order is usually placed after entering any trade in order to set a maximum loss the trader is willing to tolerate.
To set a stop loss, a trader must first identify a price point at which they no longer will want to hold the position. This may be a percentage below the entry price, a specific price level, or below a technical indicator like the moving average or support level. Common stop-loss strategies include:
- Price percentage-based: Place a stop loss X% below the entry price. For example, if a trader buys BTC at US$30,000, they may place a 5% stop loss at $28,500. This limits the maximum loss to 5% if the trade moves against them.
- Percent of capital: Some traders target a fixed percent of the total portfolio size they are willing to lose on a trade and combine it with stop loss to determine how many units they should buy. For example, if the portfolio size is US$10,000 and the trader is willing to lose only 2% (i.e., $200) on an ETH buy with a trade entry price of $1,900 and stop loss of $1,500, then the number of units to buy is 0.5 (200/[1,900-1,500]).
- Fixed price: Place a stop loss at a fixed price point. This level could be based on some commonly used technical indicators like moving averages or support levels.
- Moving average: Place a stop loss below a short- or medium-term moving average. If the token price breaks below the moving average, it indicates the short-term trend is turning down, which may lead traders to exit.
- Support level: Place a stop loss just below a key support level on the chart. Support is where the price has historically bounced back up after hitting this level. If support is breached, the overall trend may be reversing, which may lead traders to exit.
The key is to identify a stop-loss level that corresponds to the maximum loss the trader is willing to tolerate on the trade. This may vary based on risk tolerance, position size, and other factors. For instance, prudent traders might set tighter stops on larger position sizes since losses would be relatively larger than for smaller positions.
Read more about shorting in What Is Shorting? How to Short the Crypto Market.
A take-profit order (also known as a ‘take profit’) is placed to sell a crypto token once it hits a target price, thus locking in profits on the trade. Just like a stop loss, a take-profit target should be set after entering any trade.
To set a take profit, a trader must first identify a price at which they want to exit the trade and lock in profits. Common take-profit strategies are similar to stop loss and include:
- Price percentage-based: Target X% gains from the entry price. For example, target a 10% gain if the trade moves in the trader’s favour.
- Fixed price: Target a specific price level, which could be based on technical indicators like moving averages, Fibonacci extensions, and resistance levels.
- Moving average: Short- or medium-term moving averages are used to identify potential resistance levels (i.e., where exits might be warranted). Alternatively, breaks above moving averages could be interpreted that the upwards trend is intact, and it might be time to exit with gains.
- Resistance level: Target take-profit levels where the price has historically found resistance (i.e., levels where the price has historically been unable to breach upwards). This means that, once the price reaches this level, it may be difficult for the upwards trend to continue.
As with stop losses, the key is to identify a realistic profit target based on the trader’s goals, position size, and other factors. Setting take-profit levels ensures the trader actually locks in profits when trades move in their favour instead of getting greedy and watching profits potentially evaporate.
Learn more about trading signals in Top 10 Bullish Crypto Trading Indicators.
Managing Stop-Loss and Take-Profit Orders
It’s important to actively manage both stop-loss and take-profit orders throughout the trade’s lifespan. As the market environment changes and crypto tokens make large moves, factors to consider include adjusting the orders to:
- Maintain a favourable risk/reward ratio. If the token moves significantly in the trader’s favour, they could raise the stop loss up to potentially lock in more profits. Stop loss and take profit can also be combined to target a specific risk/reward ratio. For example, a stop loss targeting a $5 loss, combined with a take profit targeting a $10 gain, effectively means a risk/reward ratio of two times (in other words, risking $5 for a $10 gain) — typically, a ratio above one time would be the minimum requirement.
- Respect new support and resistance levels. Stop losses can be adjusted to new support levels and take profits to new resistance levels that emerge.
- React to key events. If important news impacts the token, or the broader market, stops and targets can be tightened to reduce risk.
- Limit losses during volatile periods. Stop losses can be widened during periods of high volatility to avoid unnecessary exits due to temporary price fluctuations. Similarly, wider stops may be used for tokens that are more volatile, and narrower stops for more stable tokens.
- Take gains if momentum slows. Profits may be taken earlier if the token’s rally shows signs of fizzling out before gains fully evaporate.
Stop losses can cut losses short, while take profits can lock in gains. Traders typically identify stop-loss levels based on price percentages or fixed prices that can be informed by technical indicators, with the potential to improve their risk-adjusted returns over time in any trading strategy. Though they require discipline and constant monitoring, these simple risk-management tools can help make a difference in trading results.
Setting appropriate but flexible stop-loss and take-profit levels — and actively managing them — is essential for risk management when trading. But it bears repeating that the discipline to adhere to the stop-loss and take-profit levels is paramount — after all, they are not helpful if the trader sets these levels but then doesn’t actually use them.
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