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Types of Trading Orders: Stop Loss vs. Profit Target

May 22, 2019 Coffee With Markus

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Types of Trading Orders

Types of trading orders: What is the difference between a trailing stop and a profit target? And which of these two is better? That’s what we’re going to talk about right now.

When trading you need to have a trading system.

There are 3 components to a trading system that you need to know:

  1. What to trade. I prefer trading stocks and options
  2. When to enter. I like to use indicators to determine my exact entry point
  3. When to exit, with a profit or with a loss

This is where the idea of a stop loss, a profit target and a trailing stop, different types of trading orders, come in.

Let’s discuss types of trading orders

types of trading orders

Let me show you exactly what I mean.

Let’s say you have a stock and you expect the stock to continue to go up. So at some point, you’re having an entry.

And let’s say you enter at $100. You’re expecting the stock to go up, so this means that you would put a stop loss below the current price, which for example would be at $90.

On the other hand, this is how you limit your risk by using a stop loss.

Now the key question is when do you take profits?

There are two key concepts. One, you can have a profit target, and this is what I personally like to do.

As soon as you see that the stock goes up to a certain level, here for example to $120, you are taking profits.

And two, there’s a trailing stop.

Let’s talk about a trailing stop

This is a question that I receive all the time: “Shouldn’t I use a trailing stop?” How does this work? What does a trailing stop do?

In a nutshell, a trailing stop works like this: as prices move higher you move your stop loss higher.

If initially you start at $90, and prices are going up to $105, as the prices move up you move your stop loss up. Meaning you would move your stop loss from $90 to $95.

If for example, now the stock keeps going higher and moves to $110, you move your stop loss again and you determine the interval.

You can move it every 20 cents that a stock moves, every 50 cents, every dollar or, as I just did here in this example, for every five dollars. It doesn’t really matter.

What is the advantage and disadvantage of having a trailing stop?

Well the advantage is that you are capturing a larger move.

If the stock keeps going higher and higher, you keep trailing your stop and the idea is to capture a larger move.

However, I found that these days the market trends are short lived and that often the stock moves up a little bit and then it goes down.

And this is why I personally like to use a profit target. I want the market to come to me. So as soon as the profit target is hit, I’m out of the market.

What are the different ways to work with a trailing stop?

First of all, you could use a fixed amount. Meaning, as the stock goes up a dollar, you move your stop loss up by a dollar.

Another way is to do it based on indicators. And one of the most popular ways to do it is doing it based off a moving average.

Now if you want to move your stop loss based on a moving average, you need to use a moving average with a rather small setting. Like for example, with the setting of 3, 5 or 7.

This way you make sure that your stop loss stays close to the current prices, that you don’t give the trade too much room.

In a nutshell, what are the pros and cons?

With a trailing stop you are expecting for the market to have a way larger move so that it really moves nice and up.

With the profit target you rather estimate that these days the markets are quite choppy and going up a little bit and then immediately going down.

This is why I personally like to use a profit target. I found that for me personally, a profit target is outperforming a trailing stop and that’s why I like to use it.

If you’d like to know exactly  how I place my stop loss and how I also determine my profit target, then go to a website that I set up for you it’s called www.mytradingroutine.com.

Now you know the difference between a trailing stop and a profit target. I hope that this helps you in your trading.

Read Next: How to Deal With Information Overload

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