Forex trading can be very exciting. You can do it even if you are new to instrument training. Traders and investors need a small capital and an internet-enabled device to jump on this bandwagon. You will also need a broker who will offer you a trading platform that you can use to trade. Most of these trading platforms offer different features that can help traders, especially the new ones, in managing their activities and keep losses on the other side. One such brilliant feature is an FX stop-loss order. When used right, this feature can save you from losing every penny.
What is Stop-Loss Order?
A Stop-loss order is an instruction placed with a broker to buy or sell a security by setting a stop loss level, a specified amount of pips away from the entry price. The Stop-loss order purpose is preventing additional losses if the price goes against the trading position.
If traders have a BUY order, Stop-loss is an order instruction that tells the trader’s broker to sell the security when it reaches your stop-loss level price. Traders are encouraged to put a stop-loss against the price beyond which they would not like to take the risk. As soon as the prices reach your stop-loss order, your broker will sell your securities before the prices move further down, saving you from bearing huge losses.
How does stop loss work?
Using Stop-loss is based on the trader behavior to make Buy or Sell position. Stop-loss level for BUY position is price level below the entry price, and target above the entry price. The Stop-loss level for the SELL position is the price level above the entry price and the target below the entry price. After entry order is made, market price fluctuates between stop loss and target price. In one moment trade will be closed if reach stops loss or target price level.
Stop-loss order losing trade example:
BUY EURUSD at 1.30, Stop loss 1.29, target 1.31. Trade will be close with profit if reach 1.31 and with a loss if touch 1.29.
SELL EURUSD at 1.30, Stop loss 1.31, target 1.29. Trade will be close with profit if reach 1.29 and with a loss if touch 1.31.
When close price reach stop-loss that is not always losing trade. Sometimes, traders move stop-loss orders when the trade is in profit, and stop loss and target bring profit for the trader.
Stop-loss order winning trade example:
BUY EURUSD at 1.3. SL in forex is 1.29. Target 1.31. When the price is 1.305 traders can move the stop loss to be 1.302. If the trade doesn’t reach the target then the trader will make a profit of 20 pips (trade reaches stop loss 1.302).
Importance of stop-loss
It goes without saying that currency prices fluctuate every day if not every minute. Forex trading is seldom the full-time job of every trader and investor. Since it is impossible for traders to stay hooked to the market at every time, a stop-loss order will mitigate the trader’s loss by informing their broker that they must sell the securities before the prices go any further down. You can decide where to put a stop-loss order after analyzing your risk-taking capacity. This feature is available to both long and short position holders.
The importance of stop loss for trading is high, based on much scientific research, experiments, and traders’ practical experience. A well-developed exit strategy, well-defined stop-loss, is an essential part of any forex trading strategy. Market condition changes during the time, and a strong market reaction can ruin trading performance without a correctly estimated stop loss level.
Forex without stop loss
Forex no stop loss strategies are dangerous strategies based on the assumption that at some point the order will be in profit. The market can be overbought and oversold for a long period of time and traders very often lose money when they risk more than that can afford. Instruction for closing trade at some price level is mandatory to the practice of experienced traders.
This feature not only saves your tangible capital but keeps you away from emotional turmoil as well. When you know that your losses will not go beyond a manageable limit, you can make trading decisions that are not burdened or clouded. The one thing that is certain about the Forex market is its uncertainty. The market can move in any direction and there is no way that anyone can predict it with utmost surety. Even if you are keeping an eye on the fundamental and technical aspects that can affect the value of a currency, you still cannot control the market. In such an unpredictable market, a feature like stop-loss can save you from drowning in debt.
A good trading strategy followed by bad money management can still leave you in troubled waters. Novice traders often go ahead with safe currency pairings like USD/JPY and EUR/USD, but still, lose money because they don’t know how to manage money. In this situation, simply putting a stop-loss order will not suffice. You must know how to calculate a stop-loss order altered to your financial needs. This has been explained further in this article.
It is evident that a stop-loss is an important tool that facilitates trading by helping traders in managing their capital and psychology. You don’t need to get trapped in the vicious circle of worrying about the unknown. It helps many traders to remain calm and make decisions that are not tainted by fear. It will keep you level-headed, which is an important virtue for any trader or investor.
Types of Stop Losses
Static stop loss
The word ‘static’ means stationary and that is what this type is about. You can put a stop at a static price and not change or move its position until the trades hit the stop-loss price. This is an uncomplicated mechanism that even new traders can understand without any difficulty. The static stop-loss allows the traders to establish that they are looking for a minimum 1:1 risk-reward ratio.
This example will help you in understanding how to use a static stop-loss. Let’s assume that there is a swing trader in LA who wants to initiate a position during the Asian session. He is expecting that volatility during the North American or European sessions will influence his preferred trades. He is aware that he could be wrong but he does not want to give up too much equity and still wants to give his trade a chance to grow. In this case, he sets a static stop-loss of 50 pips every time that he triggers a position. He wants his take-profit to be at least equivalent to the stop distance. Thus, he sets each limit order for 50 pips. This is a 1:1 risk-reward ratio. He wanted to take more risk and accept a 1:2 risk-reward ratio, he would set the static stop at 50 pips and raise the static limit to 100 pips for each trade that he will start.
In addition to the risk-reward ratio that you are comfortable with, indicators also influence how a trader would like to use a static stop-loss. Some Forex traders put a static stop distance on a technical indicator, for example, Average True Range. This is beneficial because rather than relying on their judgments, the traders are using real market information to define their stops or limits.
Isolating the concept of pips will not give you a clear picture. One must know about the kind of market that they are trading in. In the above example, we talked about a static stop of 50 pips and a static limit of 100 pips but we don’t know the kind of market that the trader was dealing in. it could be a volatile or a quiet market. The difference is that the 50 pips are not a large move in a volatile market but they are in a quiet market. Additionally, technical indicators like pivot points, price swings, and Average True Range allow a trader to utilize recent information to better devise their risk-management strategies. Therefore, it is imperative that you consider these factors before putting a static stop-loss.
Trailing stop loss
A trailing stop-loss order is an order that is not fixed, static, during the trading period. If traders have bought a security position and the market price rises, the stop price rises by the trail amount, but if the security price falls (BUY order), the stop-loss price doesn’t change.
Trailing stop-loss orders are created to reduce risk and increase profit in the moments when live positions follow the current trend.
How to calculate stop out level
The Stop-loss level in trading usually is calculated based on previous highs and lows, important price levels. Important price levels can be previous high, previous low, Fibonacci levels, pivot points.
Usually, traders find support or resistance levels, or any important levels and then set stop loss, entry point, and target price level using those levels.
Stop-loss is a resourceful tool that traders can use to keep themselves from losing their capital and to manage their risks. It is not possible for anyone to stay glued to the screen and even if you can commit to it, there are various other factors that can work against you. There could be internet problems or you might not be able to reach your broker on time. It is always better to use this tool to eliminate such risks.
Yes, your trading strategy should dictate how you would employ this tool but our recommendation would be to refrain from trading without using a stop-loss, especially if you are a new trader.