Introduction

Many traders use stop-loss and take-profit levels to determine their trade exit strategy based on the they are willing to take risks. These techniques are used in both traditional and crypto markets, but one of the most popular choices among traders is technical analysis.

Market timing is a strategy where investors and traders buy and sell assets at an optimal price level based on a prediction of future market prices. Under this approach, it is important to determine when to exit or enter the market, which is where stop-loss and take-profit levels come into play.

Stop-loss and take-profit levels are price target settings that traders set in advance. These strategies are often used as part of a disciplined trader's exit strategy, and the predetermined levels are designed to keep volatile trading to a minimum and are essential for risk management.

Stop-loss and Take-Profit levels

A stop-loss level is a predetermined price, that set below the current price of an asset at which a trader automatically stops trading when the specified price is reached in order to limit losses. Conversely, a take-profit level is a predetermined price at which a trader's asset is automatically stop trading when it reaches a predetermined profitable position.

Traders can set these levels to trigger automatic sales, rather than monitoring the market 24/7 and using market orders in real-time. For example, Binance Futures has a stop-order function that can be used to combine stop-loss and take-profit orders. The system decides whether an order is a stop-loss or take-profit based on the trigger price level and the closing price or mark price at the time the order was placed.

Benefits of Stop-Loss and Take-Profit Levels

Exercise risk management

Stop Loss and Take Profit levels represent the current dynamics of the market, and those who know how to use these methods correctly can essentially identify the levels of benefit and risk in trading. Assessing risk through the use of stop loss and take profit levels can play a significant role in preserving and growing your portfolio. By prioritizing low-risk trades, you are not only protecting your systematic holdings but also preventing your portfolio from being completely wiped out. Therefore, many crypto traders use stop loss and take profit TP levels in their risk management strategies.

Absence emotional trading

One's emotional decision at any given moment can greatly influence, this is why some traders rely on a pre-determined strategy to avoid trading under pressure, fear, greed, or other strong emotions. Learning to identify when to close a position can help you avoid trading on emotion, allowing you to manage your trades strategically rather than fancifully.

Calculate risk-to-reward ratio

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

The measure of risk taken for potential reward is commonly called risk-to-reward. It is better to enter trades with a relatively low risk-to-reward ratio because it means that your potential profit is greater than the potential risk.

You can calculate the risk-to-reward ratio with 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 various methods that traders can use to determine the best stop-loss and take-profit levels. These methods can be used alone or in combination with other methods, but the ultimate goal is the same: to make informed decisions using more existing data about when to close a position.

Support and resistance levels

Support and resistance are familiar key concepts to any technical trader in both traditional and crypto markets.

Support and resistance levels are areas on a price chart where there is a potential for increased trading activity when buying or selling an asset. At support levels, a downtrend is likely to be halted due to increased buying activity. At resistance levels, an uptrend is likely to be halted due to increased selling activity.

In this way, traders usually set their take-profit level just above the support level and their stop-loss level just below the resistance level.

Moving Averages

This technical indicator filters out market turbulence and smooths price action data to highlight trends.

Moving Averages can be calculated for the short or long term, depending on the individual trader's preference. Where two different moving averages cross on a chart, traders closely monitor the moving average to take advantage of the opportunity presented by the crossover signal. You can read more about moving averages in more detail.

Typically, traders using moving averages recognize stop-loss levels below the long-term moving average.

Percentage method

Some traders use a fixed percentage to set stop loss and take profit levels, rather than a pre-defined level calculated using technical indicators. For example, they may choose to automatically close their trades if the price of their asset moves 5% above or below the entry price. This is a simple method, for those who are not very familiar with technical indicators that works very well for traders.

Other indicators

We have mentioned some common technical analysis tools to use to set stop loss and take profit levels, but traders use many other indicators. Tools that traders use include: the Relative Strength Index (RSI), which is a momentum indicator that signals when an asset is overbought or oversold, Bollinger Bands (BB), which measure market volatility, and Moving Average Convergence Divergence (MACD), which uses exponential moving averages to plot data points.

Conclusion

Many traders and investors use one or more of the above methods to calculate stop-loss and take-profit levels. This provides technical support for exiting their trades to either close out a losing position or realize potential profits. Keep in mind that these levels do not guarantee absolute success for every trader. Instead, they guide their decision-making and make them more disciplined and empowered.  It is a good trading strategy, assessing risk identifying stop-loss and take-profit levels or using other risk management techniques.