Abstract：As a forex trader, your first responsibility is to protect your trading account from being obliterated by Forex losses.
One of the beast ways to ensure this does not happen is to use a stop-loss order to limit your risk exposure. Stop losses are most effective at protecting capital from being lost through indecision. The proper use of stop losses can increase the degree of control an individual has in managing risk. In this article, we will discuss the main points related to a stop-loss in forex and list some effective strategies for placing stop orders.
What Is A Stop Loss？
A stop-loss order is a type of advance order that allows you to automatically exit a position in order to limit losses and reduce risk exposure when price movements are more adverse than you are willing to accept. Sometimes called a stop loss, stop order or stop market order, this tool is an automatic instruction to sell an open position when the price drops to a pre-set losing limit, ensuring your losses do not grow too big. As the stop loss is a standard free feature of all trading platforms, it's one of the most important risk management tools in a forex traders armoury to mitigate against losses. There are 3 types of stop loss orders:
Percentage Stop
A percentage stop loss order is exactly what it sounds like. Instead of telling the broker at what exchange rate you'd like your order to be closed, you simply tell them what percent of your entire invested amount you are ready to lose. For example, if you are willing to risk 3% of the value of your trading account, you can set a stop-loss equal to 3% of the size of the account.
Volatility Stop
A volatility stop is when a trader indicates how much volatility of an asset is too much for them. Setting your stop-loss based on volatility is a prudent method given that it is based on a currency pair's price movements in the past, which can be a good indicator of future performance.
There are a number of ways you can track volatility in order to place your stop-loss order at a safe distance with the most popular ones involving the use of Bollinger bands and the average true range (ATR) indicator.
Chart Stop
A chart stop is the most common stop loss order of them all. For example, if you the current exchange rate of EUR/USD is 1.18156 and you think that it may increase to 1.20000 but you are not really sure. Other signs say that it could even drop to 1.15000. So, what you do is you place a stop loss order at 1.16000. If the exchange rate drops to this amount, it's almost guaranteed to continue falling, so it might as well cut your losses short with this order.
In general, Stop-Loss orders for SELL trades are always placed above entry / current price, while Stop-Loss orders for BUY trades are always placed below entry / current price.
Time Stop
These stop-losses are set based on a pre-specified period. For instance, you can choose to close a trade position at the close of the day, or when the Tokyo-London overlap is over. On Friday, you can decide to close the trades you don't wish to hold over the weekend .
Why Is A Stop Loss Important？
No matter how closely one might try to monitor the market, it is impossible to accurately predict Forex market movements. even the savviest trader can find themselves on the adverse side of a market move. When severe market dips happen, stop loss trading can help to close out your position and prevent excessive losses.
Stop-losses prevent large and uncontrollable losses in volatile trades. If youre not using stop-losses, it's only a matter of time when a large losing position will get out of control and wipe out most of your trading profits, eventually even your entire account. Here are some advantages of using stop loss orders:
-It provides protection from excessive losses
-Enables investors for better control of their account
-Helps to monitor multiple deals
-Automatically executed
-Easy implementation
-Allows you to decide the amount you are willing to risk
-Promotes discipline
Tips on Using Stop Loss in Trading
To set your stop loss like a professional trader in forex, here's what you have to do:
1. Determine your stop-loss placement in advance
Before entering into a trade, you need to be very clear on the level of risk you will take in that trade. If you have no idea where you should place your stop-loss or when to get out of that trade, then don't take this trade.
2. Avoid very tight or wide stops
Avoid using very tight stop-loss orders unless the trade setup warrants such a move. For example, if you have a profit target of 100 pips on the EUR/USD currency pair in a volatile market, you are better served using a wider stop-loss to accommodate the price volatility.
The opposite of very tight stop-loss orders is very wide stop-loss orders, which either increase your chances of making huge losses by being overly exposed to the markets or cause you to trade very small positions. Follow the above guidelines to ensure that you place your stop-loss orders at the right distance, neither too wide nor too short.
3. Use a simple stop-loss strategy
Trade in the overall trending direction with a simple stop loss method. Don't complex your trading journey with multiple stop loss method. Choose one which is logical and straightforward to you.
4. Do not set stop loss on support and resistance levels
Never place your stop-loss orders exactly on a resistance or support line as price tends to whipsaw around such areas as the bulls and the bears fight for control. Always leave a safe distance between a support or resistance level and your stop-loss order.
