In the process of foreign exchange trading, do you often find that after the price hits the stop loss point, it reverses and develops towards the profit stop point? Or do you often see the price is about to hit the take profit point, but suddenly reverse to the entry point?
These two situations are really easy to cause headaches. But in fact, the explanation for these two situations is very simple: you set the wrong stop loss point and take profit point.
The price often hits the wrong stop loss point, and the wrong take profit point is hard to reach. It is precisely because of this that many traders make small profits and large losses.
However, in the foreign exchange market, there are people who lose money and those who make money, and many people make profits of more than 100 points. How do such masters set stop profit and stop loss to lock in big profits?
Today we will introduce to you a simple method commonly used by foreign exchange masters to set the best take-profit point and stop-loss point - the STEP method.
01 Example of Short Reversal Trading
Why do masters like to use the STEP method? Because the STEP method works for almost any trading setup!
But in order to better understand the trading strategy, I will use an example to explain these concepts. Here, I have chosen a reversal trade, which is one of the main trade setups of a free price action strategy.
First, let's make a simple transaction setup.
Pictured above: This is a short reversal trade setup. We are entering short from the resistance zone after a strong indecision candle formed.
At this time: Stop loss is placed above the high of the resistance and indecision candle, and take profit is placed above the next support zone.
Why should we set the stop loss point and profit stop point in this way? we will talk about
02STEP method
The STEP method provides us with a very easy-to-remember step when setting the best take-profit point and the best stop-loss point for each transaction.
First of all, let's familiarize ourselves with the basic steps of using the STEP method:
Stop (stop loss point): When we find a potential transaction, the first thing we need to do is to determine the safest and best stop loss point;
Target (stop profit point): Next, we need to find the best profit stop point. The price of the optimal take-profit point should be easily accessible and at the same time give us a good profit;
Entry: The next step is to choose the right entry point and make sure we have a good risk reward ratio.
Place (entry transaction): After setting the stop loss point, take profit point and entry point, we can enter the transaction.
Next, let us break down the STEP method more concretely and step by step.
1 Set the best stop loss point
When setting a stop loss point, the first thing we need to do is to make sure that the stop loss point is set behind the barrier. What is an obstacle?
Support and Resistance Zones
nearby highs and lows
psychological level
Going back to the trading example from the beginning of the article, let's see why we set our stops the way we do.
1. Support and resistance zones
We plan to short the USD/CAD currency pair. When looking for stops on a short trade, the first thing to look for is the resistance zone (marked 1 in the diagram). We are going to use the resistance zone to get a safe stop loss position!
When trying to set a stop loss, keep it above resistance (or below support for long trades). Such a setup will give us a huge advantage in trading.
After entering a trade, there will often be a pullback. Sometimes, the retracement even exceeds the entry point.
Most traders know the pain of getting out of a position early due to a retracement, and then we just watch as the price then pushes back towards the original prediction with nothing we can do.
So, setting the stop loss point above the resistance level means: on the retracement, the possibility of the price touching it is very small.
Here's why: Resistance is a barrier to price, while retracements are usually weak price moves. Weak price moves tend to fail when barriers are encountered, so it is crucial to place stops behind barriers!
2. Nearby highs and lows
In addition to placing the stop loss above the resistance level, we also need to place it above the recent high (or in the case of a long trade, below the nearby low).
It is more difficult to make new highs when the bulls lose control of the price, so placing a stop above a nearby high provides additional protection (marked 2 in the chart above).
At this time, we may realize (especially for novices): in order to obtain a better risk-reward ratio, we must formulate stricter stop-profit and stop-loss measures.
But trading involves risk management, and we need to leave enough space for the transaction to ensure that reasonable price changes are allowed without losing a transaction.
Successful trades often experience pullbacks. So, placing your stop loss above the nearby high on a short trade or below the nearby low on a long trade can provide some extra protection.
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3. Psychological level
The psychological level is an additional hurdle, and we can sometimes use psychological stops. Psychological levels can be yearly highs or yearly lows, or larger numbers like USD/CAD 1.0000.
These levels are important because they function as a psychological barrier. Markets are driven by people, and people respond to psychological levels.
In the chart above, we placed our stop above the yearly high (marked 3 in the chart) because we expected the yearly high to act as a psychological barrier, making our stop safer.
In a word, the key to the best stop loss point: set it behind as many obstacles as possible.
2 Set the best profit stop point
The key to setting the best profit stop point can be summed up in three words: look to the left. When looking for a take profit location, first look to the left at the nearest point where the price stalled.
In the image above, the trade tool (the green and red stuff) shows potential trades.
Why set the profit stop point like this?
On the left, we see that the price has stalled around the area marked by the blue line three times in the past few weeks. This area represents lesser resistance and is therefore a hurdle.
We want to make sure that the take profit point is set in front of or at the barrier. This is also the easiest way to set a take profit point.
3 Find out the entry point (risk reward ratio)
Finding a good entry point is relatively simple as it only needs to meet two conditions:
Entry rules in line with trading strategies
Good risk reward ratio
Generally speaking, the setting rule for the risk-reward ratio is 1:2. Taking a stop loss of 50 points and a stop profit of 100 points as an example, the risk-reward ratio at this time is 50:100, which is 1:2 after simplification.
For the examples we have used so far, the entry point would be below the low of the indecision candle. This is the most basic type of entry because it works so well.
Choosing this method to confirm the entry point, we can not only enter the market at a good price, but also have a good risk-reward ratio.
The risk reward ratio we set here is 1:2, which means that the take profit is twice the stop loss. In other transactions, we can also set the risk-reward ratio according to the actual situation, but generally it is more than 1:2.
4 entry trade
After completing the setting of stop loss point, profit stop point and entry point, we can enter the market. If we can follow the first three steps, then our transaction is basically safe.
In other words, it is difficult for the price to touch the stop loss, but it is easy to touch the stop profit.
03 last
Some people say that finance is a gamble, but I don’t think it is, on the contrary, I think it is a game, just like playing chess, you never know which chess piece your opponent is playing, but you have to watch the direction of the board, you Decide which chess piece to play by yourself, you must be able to advance and retreat in a certain way, and your mentality must be stable.
Don't be greedy, don't panic, just like walking in life, take every move well, don't think about getting rich overnight, but put your energy on a long-term plan, set a good stop profit and stop loss, and make progress steadily, then You are not far from success!
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I hope this article can make foreign exchange traders get out of the confusion when they are in confusion. Old rules, if you haven't understood it, please bookmark it first! Welcome to leave a message to communicate with the editor!
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