A stop-loss order is an order that is placed by a trader on a trade he/she entered to minimize the possible losses that could be made on it. It can also be described as an order that can be placed with your broker which permits your broker to sell a security or a currency pair when it reaches a particular price or exchange rate.
A stop-loss order is a very useful tool for a forex trader as it can be attached to either a long or short trade and it doesn’t require you to be present to function. That’s right. A stop-loss order can work even when you are not able to monitor the market or away from your device.
Why Should We Use Stop-loss Orders?
“Live To trade another day”, is a motto that would probably exist in the mind of a Newbie in the market because a prolonged survival on the market will increase the amount of learning and experience you will gain in the market which will lead to a higher odds of making gains on the market. If one was to lose all of his trading capital, that’s it.
There is no way to recover the amount and the very unpredictable nature of the market doesn’t help matters. One minute the exchange rate could be on the rise and the next, a single event or report could turn the prices the other way faster than you could imagine. Everyone will make losses over time in the market. It’s inevitable. But as a trader, you should be able to limit the size of the losses and this is what makes the trade management technique of “stop losses” an important skill in a trader’s arsenal.
Having an already determined point of exit on a losing trade not only provides the benefit of mitigating losses so that you may move on to new opportunities, but it also eliminates that anxious feeling you get as a result of losing a trade without a plan.
Forex Stop Loss Strategies
There are numerous stop-loss strategies that you can use as a trader to limit your losses. For the sake of this article, we will be studying two major strategies and how to use them.
Making Use Of Static Stops
Forex traders can decide to assign stops at a static price level, with the aim of allocating the stop-loss, and not adjusting such stop until the trade eventually reaches that stop. What makes this strategy so easy is its simplicity and it allows traders to specify that all they want is a minimum 1:1 risk to reward ratio.
Let us briefly analyze this example.
A swing trader in Los Angeles decides to initiate positions during the trading session of Asia, with the hope that volatility during either the North American or European sessions will influence his trade. His aim is simply to give his trades’ sufficient room to work, whilst not giving up too much equity on the off chance that they might be wrong.
He and his team decide to set a static stop of 50 pips on every single position they enter. Consequently, they want to set a take profit at least as large as the stop distance. At this point, each limit order is then set for a minimum of 50 pips. If the trader wants to set a one to two risk to reward ratio on each trigger they make, they will simply set a static stop at 50 pips but the static limit will then be at 100 pips, for every trade they start.
Traders can also decide to make use of static stops based on indicators. This should be taken into high considerations if you ever wish to make use of the stop loss while trading on the Forex market. Most traders engage the power of technical indicators, such as the Average True Range, in order to determine how to base their static stop distance. A major benefit to this is that they are using actual market information to assist in setting the stop.
Making Use Of Trailing Stops
Static stops are sure to bring in some considerable benefits to a new trader’s approach. However, other FC traders have now improved on their concept of stops and are taking steps further so that they can concentrate on optimizing their money management. Trailing Stops are stops that are flexible as they can be adjusted when the trade moves in the trader’s favor, so as to limit the downside risk of being on the losing side in a trade.
For example, if a trader was to take a long position on a currency pair, let’s say the GBP/USD pair at 1.2400, with a 50 pip stop of 1.2350 and a 100 pip limit of 1.2300. if the trade was to move up to 1.2450, the trader may consider shifting his stop up 1.2400 from the initial starting stop value of 1.2350. A trailing stop moves the stop loss to their entry price or break-even price. What this does is that it protects the gains made from the original position if the currency pair eventually reverses or moves against the trader.
This break-even stop allows the trader to remove the initial risk on their trade, leaving them with the decision to either place that risk in another FX trade opportunity or keep the risk amount entirely out of play and settle with a protected position in the long GBP/USD trade. There are many variations of the trailing stops which include the dynamic trailing stop, manual trailing stop, and the fixed trailing stops, which adjust in fixed increments set by the trader.
The importance of utilizing stop-loss orders while trading on the Forex market cannot be overemphasized. Every single trade you enter on the Forex market is a risk. With a stop-loss order, these risks can be managed and your losses cut down.
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