Take Profit and Stop Loss

Take Profit – A take profit order has an intent to sell or buy the security at a given price that the investor chooses. For example, if an investor buys a stock a $10 and sets a take profit target of $15. Once the stock reaches $15 the take profit order will execute a market order to sell at the best price leaving the investor a $5 profit.

Stop Loss – A Stop Loss order is similar to a take profit order however is usually in the opposite direction. Using an example, an investor buys a stock at $10 with his take profit at $15, but he also sets a stop loss of $6. Therefore, if the stock dropped $4 the stop-loss order would execute and the investor would lose $4.

Trailing Stop-loss.

A trailing stop loss allows an investor to pre-set a maximum fixed distance from the current price, so long as the trade/investment is moving in your direction. If the prices go against the investor, the trailing stop loss will hold until it gets it.

Let’s say for example you buy an index fund that has a current price of 1,000pts and you set a trailing stop distance at 100pts. The value of 100pts would be the fixed distance so if the index fell 100pts to 900pts, your trailing stop would be executed. Now, let’s say in this example the index fund goes up 200pts to give a current price of 1,200pts. Your trailing stop would now be 1,100pts because your fixed distance has stayed the same at 100pts, therefore, resulting in your trailing stop becoming 1,100pts. In this scenario, you have locked in profits!

The Advantage: Investors can lock in profitable trades while allowing a position to run further and not worry about a price decline.

The Disadvantage: If prices rapidly decline and the trailing stop is hit but then prices recover the trade then becomes void.

Trailing stop losses are designed to be used on profitable trades and while using them in loss-making trades still works, it might not be the best method of stop-loss.

Guaranteed Stop-loss

A guaranteed stop-loss works very similar to a regular stop-loss with 1 exception, there is a guarantee. In most cases, a trailing stop-loss or regular stop-loss will work regularly and close a position upon reaching the Stop target. If a trader has a stop-loss in place but the market gaps down or up below/above the level then the Stop-loss will execute but at the given open price. As a result, the investor could lose more than the Stop-loss amount, an example is below.

James buys 1 share of ABC Inc. at $500. He sets a stop loss at $480 Meaning he thinks he can only lose up to $20 on this investment, however, the next day ABC Inc. opens at $450. Because James has only a regular Stop-Loss in place the trade will execute at the open price of $450 and not his $480 stop-loss. As a result, James will lose an additional $30 on top of the $20.

A guaranteed stop-loss would still ensure that even in the event of a gap up/gap down the investor loses the amount they initially set. In most cases, a guaranteed stop loss is charged at a premium which could be a fixed amount on top or a percentage of the asset. Further to this, not all markets have the option of a guaranteed stop loss, so this needs to be considered when placing a trade.

Market Order

A market order is a type of trading order which has the intent to request a buy or sell position at the best available price from your broker. This is quite a common type of order and allows for instant execution upon pressing the buy or sell button.

While this may seem like the best type of order to execute there are some disadvantages. Because it’s an instant execution order there is no guarantee on a particular price therefore the price at which the order is executed won’t be truly known until after the button is pressed. As a result, you could end up with a different price from what is displayed. The asset's liquidity is a major factor in determining the market order price accuracy.

Market orders are often used when the investor is perhaps not too concerned about the exact price they may get and the same scenario applies when selling the asset, the investor is not too concerned about the price they may get while exiting the trade. In high liquidity stocks, such as Apple and Microsoft price action is accurate, fast and reliable as there are a lot of buyers and sellers therefore market order executions are good. However smaller cap stocks may not have the volume and therefore the price execution could be poor – usually, with small-cap companies, a fixed Price Quote is the better or only option.

Fixed Price Quote

Similar to a Market Order, a Fixed Price Quote allows an investor or trader to get a price from the broker or market maker at a guaranteed level, but this may only last a few seconds before the price has to be requoted again. The benefit of a Fixed Price Quote, as opposed to a market order, is that it allows the investor to decide whether that price is adequate for them, if they agree, the price is executed in the same way a market order is executed however the quote given is the price you will receive on the trade.

Limit Orders

A limit order is a pending order for a purchase of a security. It allows investors and traders to buy securities at a guaranteed future price, provided the security reaches the limit order put in place. Limit orders are good as they allow the investor to buy at an exact price based on what they are willing to pay. There are 4 kinds of limit orders:

Buy Limit: An order to purchase a security below the current market price at a specified level. For example, if a stock is $10, a Buy Limit can be set at $6 to buy the security at that price or better.

Sell Limit: An order to purchase a security above the current market price at a specified level. For example, if a stock is $10, a Sell Limit can be set at $14 to sell the asset at the price or better. In this example, an investor would be betting against a stock (also known as shorting).

Buy Stop: An order to purchase a security above the current market price at a specified level. For example, if a stock is $10, a Buy Stop can be set at $13 to buy the security at that price or better. In this example, an investor would be buying the stock in the hope it rises further in value.

Sell Stop: An order to purchase a security below market price at a specified level. For example, if a stock is $10, a Sell Stop can be set at $8 to sell the security at that price or better. In this example, an investor would be betting against a stock (also known as shorting). Usually, this order would be placed if a trendline had been broken. All of these orders are very similar in the way they work, but if you’re still struggling to understand this, we have a video below explaining the most important orders.