Stop-Loss and Take-Profit
Decide in advance how much you'll lose before you get out and how much you'll take when you're up. Let discipline make the call.
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Text version · Stock Trading: Next Steps, lesson 6: “Stop-Loss and Take-Profit”
Decide in advance how much you'll lose before you get out and how much you'll take when you're up. Let discipline make the call.
Stop-loss: get out if the loss reaches here
A stop-loss is an "I was wrong" line you set in advance. When long, it sits below your entry; the moment price touches it you sell automatically, so you know your maximum loss.
Take-profit: cash in when the gain reaches here
A take-profit locks in your target profit. Stop distance : target distance is the risk/reward ratio.
Stops slip too when price gaps
Once triggered, a stop-loss usually fills at market. When overnight bad news causes a gap, price jumps right past the stop line, and the fill can be much worse than the stop price. To have your stop follow your profit, use a trailing stop.
Key takeaways
- Stop-loss: automatically closes your position when the price moves against you to a set level, capping your loss on the trade.
- Take-profit: automatically closes your position when the price hits your target, locking in the gain.
- Risk/reward ratio = potential loss : potential gain. A common target is 1:2 or better.
- A triggered stop usually fills at market, so a price gap can fill you worse than your stop price.
Try it yourself
You can do these exercises in this lesson's interactive simulation:
- Default settings: buy at $50, stop-loss $45, take-profit $60. Read off the risk/reward ratio on the right.
- Pick "Dip, then bounce" and play: which line is touched first? Does the big rally afterwards still matter to you?
- Switch to "Short": which side of the entry price do the stop-loss and take-profit move to? Then play "Steady fall".
- Pick "Choppy" and shrink the stop-loss or take-profit distance (or drag the red stop-loss line and the green take-profit line on the chart) until one of them is hit.
Quiz and explanations
- 1. You buy at $50 with a stop-loss at $45 and a take-profit at $60. What's the risk/reward ratio?
- Answer: 1:2.Risk $5, reward $10: 1:2.
- 2. When you're long, where should your stop-loss go?
- Answer: Below your entry price.A long position is hurt by a fall, so the stop goes below.
- 3. You buy 100 shares at $50 with a stop at $45. Bad news comes out overnight and the stock opens at $42. The stop triggers and fills at about $42. Roughly what's your actual loss?
- Answer: $800.A triggered stop fills at market, and the gap makes the fill $42: (50 − 42) × 100 = $800, which is $300 more than the planned $500.
Terms in this lesson
- gap (Gap): When price jumps to a new level between sessions without trading at the prices in between.
- pip (Pip): The smallest standard price unit in forex; for EUR/USD, 1 pip = 0.0001.
- risk/reward ratio (Risk : Reward): Money you could lose : money you could make; 1:2 means risking $1 to aim for $2.
- stop-loss (Stop Loss): Automatically closes a position when price moves against you to a preset level, capping your maximum loss.
- take-profit (Take Profit): Automatically closes a position when price reaches your preset target, locking in the profit.
- trailing stop (Trailing Stop): A stop-loss that follows price in your favor (on a long it only moves up), protecting your capital while locking in some profit.