Placing Stop Losses And Take Profits Effectively

There is no rule of thumb when setting stops or take profits but generally you will want to keep your risk to reward a minimum of 1, preferably 2 or higher.

In case you're not familiar with R:R, it is how much you intend to risk vs. how much you intend to gain.

An R1 would mean you are risking as much as you intend to gain.

An R2 would mean you are targeting twice what you are risking.

These are controlled by stops and take profits.

An R1 would mean your stop and take profit are equal.

An R2 would mean your take profit is twice your stop loss.

A lot of new traders will formulate a plan as they've been instructed whereby they will be adamant at using a particular R:R such as 2:1, they will spot a setup and decide they want to trade intra-day so there stop will be 30 thus giving them an automatic take profit of 60.

These kind of trades are unlikely to be very profitable as there is no real premise behind the placement of stops or take profits.

You should take support and resistance into consideration when placing stops and take profits, and by support and resistance I'm referring to drawn up horizontal lines across recent highs, lows, double/ triple tops or bottoms, trend lines and Fibonacci retracements. The strongest support and resistance will be where several of these coincide, you can also try to spot candle patterns forming around the S + R areas or lines for extra confirmation.

Using the methods mentioned above, begin to work out the distance between your entry, nearest support/s and resistance/s to begin planning your trade and working out your risk: reward ratio.

For example you plan on entering at the market on the Usd/Jpy pair at a price of 89.65, you have establish a very strong resistance at 90.00 and a very strong support at 88.60. your entry is 35 points from resistance and 105 points from support, if you take a short position you would have a trade with a risk: reward ratio of 3:1 which is by any standards a very nice trade. You will most likely then want to tweak this slightly by putting your stop say 10 points above resistance and your take profit 10 points above support, you have now greatly increased your chance of protecting your stop and price reaching your target whilst still maintaining a R2+.

Hope this has helped, sorry if some of it seems as though I'm pointing out the obvious to some but a lot of new traders find this harder to grasp than you may think, I have in the recent months starting teaching trading to some wealthy clients and as intelligent as they are, they sometimes really struggle with certain concepts.

Lee J Brown

http://www.ProFXBlog.com