Stop loss, take profit and risk/reward: how to set them before you enter a trade

Decide the exit before the entry

Every trade has three prices: entry, stop and target. The stop is where you accept you were wrong and exit with a small loss. The target is where you take the gain. Setting both before you enter takes the decision out of the heat of the moment, when fear and greed tend to speak loudest.

Where to put the stop

The stop belongs at the point where the trade idea stops making sense, not at a round number picked for comfort. In a breakout above a high, for example, price falling back below the broken level invalidates the reason for the entry. That is why, in this strategy, the stop usually sits below the recent lows.

Risk/reward

The risk/reward ratio compares how much you can gain with how much you can lose. If the stop is $2 below the entry and the target is $5 above, the ratio is 2.5 to 1.

At 2.5 to 1, you can be wrong more often than you are right and still finish ahead. Win 4 out of 10 trades and you gain 4 times 2.5 and lose 6 times 1, leaving 4 units of risk before fees. Fees and funding shrink that number, which is why the Aval scoreboard already shows results with them deducted.

A worked example

Notice that position size comes from the stop, not the other way around. A wider stop calls for a smaller position to keep the same dollar risk.

• Entry on SOL at 182.40. Stop at 179.20. The distance to the stop is 3.20 per coin.
• Target at 2.5 times that distance: 182.40 plus 8.00 gives 190.40.
• A $10,000 account and a maximum risk of 1% per trade: you accept losing $100.
• Position size: 100 divided by 3.20 gives about 31 coins, or close to $5,700 of exposure.

Limits that apply to every trade

Beyond the stop on each trade, it pays to have limits on the whole account. Aval uses a maximum daily loss, a maximum size per position, a maximum number of open positions and automatic pauses: three stops in a row pause new entries for six hours, and a stop on one coin pauses that coin for two hours. Not even auto mode can break any of these limits.