Monday, June 8, 2009

Bigger Stop Loss or Bigger Take Profit?

This is a question that has generated a considerable amount of debate. Should a trader set a bigger stop loss for a trade or a bigger take profit? Well, these basic scenarios can occur:

1. Bigger Stop Loss, Smaller Take Profit
Winning would be easier because the market will reach the Take Profit faster than it will reach the bigger stop loss and the probability that it will reach the Take Profit would be more, assuming it really does go that way within the time that the trade is open. So you would be winning more than you lose… hopefully.
But, the money lost would be more than the money won in trades. Because when you take small profits, you do not reap in much cash, whereas when you stop bigger losses, you might be wiping out a lot of your capital.

2. Bigger Take Profit, Smaller Stop Loss
Winning would be harder and losing would be easier, the complete opposite of the first scenario. Unless the market really moves in your direction! But when you win, you win a lot more and when you lose, you lose a lot less.

What is the ideal scenario then? It would all depend on your trading strategy. If you are sure that you can win lots of small trades that can cover up for a few big losses, then you can go for the 1st option. If you would rather win less but win big and can cover up for several small losses, then you can go with 2.

But the best is still to make a good analysis, so that you can really be sure that your trade would be a winner, and then go with option 2. But only if that were that easy…

• Posted by josh at 20:34:06 in Financial Management
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