J.E. Forex Setting The Parameters of a Trade

Stop losses and Take profits
Stop losses and Take profits are key to carrying out risk management in trading as they set the parameters of a trade. They both mark points where a trade will automatically close if the price reaches them.

A stop loss (SL) marks the maximum loss that you are willing to make in a trade, meaning the stop loss is also your total risk on a trade. Take profits (TP) are the maximum gain you can make from a trade, they are your maximum target for the price to move.

The image above shows a valid set up for selling USDJPY on the m15 time frame. Overall, momentum is down and the price broke out of a zone that it had been in for some time - as it had been in this zone for a while it is likely that the price movement would be strong, as it was.

The stop loss is placed above the previous zone and market structure as indicated in the image. It is placed here because if it is hit it means that were completely wrong in the trade and price did not break the way we expected. This is because to hit our stop loss price would have to go back up in to the zone and break above it - the opposite direction of break to what we think by taking sells. Personally, I set my stop losses 3/ 4 pips above/ below zones or market structure because that is usually far away enough to avoid any liquidity grabs or retracements. The below image shows the m5 chart of the same trade, with the SL placed 4 pips above market structure (the previous high on m15 chart above), which also happens to be around 4 pips above the zone.

Take profits are placed at the nearest next zone or major ema, as these are the points where the price will most likely react due to support or resistance. As you can see in both images here, take profit would be placed just above the lower zone and momentum continued strongly down to it. This is a textbook zone to zone trade where momentum is very strong, there is very little/ no draw down and the TP is hit and broken.

Above is an example of how we place the stop loss above market structure (the wicks that mark the high we are selling) and how we can place take profits at the next support, which is also the the previous low. The below image shows the same chart but on h1 from the next day and shows how this trade played out. This trade moved through the take profit and did not hit stop loss, and also maintained a risk reward of 2, which leads to the next parameter of a trade.

Risk Reward Management

Risk Reward is the level you are willing to risk for a certain level of reward. A good level to aim for is a minimum of 1:1 risk reward ratio, which means you are willing to risk 1 for every 1 you could gain (for example; your stop loss is 10 pips while your take profit is also 10 pips). This is important because a consistently good risk reward means you don't need a high win rate in order to be profitable. Say your risk reward is always 1 to 1:

Out of 100 trades, you can win 50 and lose 50 and be on break even, as for every 1 you lose you also win one. Therefore with only a 1:1 risk reward you can have anything above a 50% win rate and be profitable. Obviously, if you increase your ratio, for example to risking 1 for every 2 you gain (example: a stop loss of 10 pips but a take profit of 20 pips), you can lower your win rate even further to be profitable.

If you are already profitable, having a good risk reward ratio can help increase your profits massively whilst still minimising risk. As a result, Risk Reward Management is key to any good trading plan.