What's a Stop Loss Order? and What to Consider When Setting
Stop Loss is a type of order which is placed after opening a trade that is designed to minimize losses if the market trend goes against you.
It is a predetermined point of exiting a losing transaction & it's meant to control losses.
A stop loss is an order placed with your broker that will automatically close your trade transaction when it reaches a predetermined price. When set level is reached, your open trade is closed out.
These orders aim to restrict the sum of funds that trader can lose: by closing transaction if a specific price that is against the trade is reached.
Regardless of what you might be told by others, there's no question about if these orders should or should not be set - these orders should always be set.
One of most trouble some things in Gold is setting these orders. Put the stop loss too close to your entry price & you're liable to exit the trade due to random volatility. Place it too far away and if you are on the wrong side of the trend, then a small loss could turn into a large one.
Critics will point out several disadvantages of these orders: that by placing them you are guaranteeing that, should your open position move in the wrong direction, you will end up selling at lower trading prices, not higher.
The skeptics also will argue that in setting stops you are vulnerable to exit a transaction just before the market moves in your favor. Most investors have had the experience of setting a these orders & then seeing the price retrace to that level, or just below it, and then go in the direction of their original market trend analysis. What may have been a profitable trade position now instead turns into a loss trade.
Experienced traders always use stop orders as they are a crucial part of the discipline required to succeed because they can limit a small loss from becoming a large one. What's more, by purposefully placing these orders whenever you enter a position, you end up making this important decision at the point in time when you are most objective about what is really happening with market, this is because most objective technical analysis is done before opening a trade transaction. After opening the market a trader will tend to analyze the market differently because now they have a bias toward one-sidea-particular-side, the direction of their analysis.
Unexpected news can come out of nowhere and significantly affect the trading price: this is why it is so important to have a stop order. Its best to cut losses early when a trade is going against you, it's best to cut your losses immediately instead of waiting it to become a big one. Again, if you set your stops when you are entering a trade, then that is when you're most unbiased.
A key question is exactly where to place this order. In other words, how far should you place this below your purchase trading price? Many traders will tell you to set pre-determined - maximum acceptable loss, an amount that's based on your account equity balance rather than use of technical indicators of the xauusd in question.
Experienced money managers instruct that you should not lose more than 2 percent of your account equity on any one xauusd transaction. If you have $50,000 in capital, that then would mean the max loss that you should preset for any one transaction is $1,000.
If you bought 1 standard lot of a instrument, then you'd limit your risk to no more than $1,000. In that case you'd put your stop order at 100 pips (points) & would have $49,000 left in your account if you exited the trade position at the max loss allowed. The topic of risk management is wide and it's covered under money management topics.
What to Consider When Setting
Most important question is how close or how far this order should be from the price where you entered the position. Where you set will depend on several factors:
Since there are not any rules cast in stone as to where you should set these zones on a chart, we follow general guidelines that are used to help put these levels correctly.
Some of general guidelines used are:
1. Risk - How much is one willing to lose on one transaction. The general rule is that a trader should never lose more than 2 percent of the total account capital on any one transaction.
2. Volatility - this refers to the daily trading price range of a xauusd. If a trading price regularly moves up and down in a range of 100 pips or more over the course of the day, then you cannot set a tight stop loss order. If you do, you'll be taken out of the trade by normal market volatility.
3. Risk to reward ratio - this is the measure of potential reward to risk. If the market conditions are favorable then it is possible to comfortably give your trade more room. However, if the market is too range-bound it then becomes risky to open a transaction without a tight stop then don't make the trade at all. The risk to reward is not in your favor & even placing tight stop orders won't guarantee profitable results. It would be more wiser to look for a much better trade transaction next time.
4. Position size - if the position size opened is too big then even the smallest decimal price movement will be fairly large in percent terms. This means that you have to put a tight stop loss which might be taken out more easily. In many cases it is better to shift to a smaller trade transaction so-as-tosothat-to allow your trade transaction more room for fluctuation, by putting a rational level for this order while at same time capping risk.
5. Account Capital - If your account is under-capitalized then you will not be able to set your stops accordingly, since you will have a big amount of money in a single trade transaction which will constrain you to set very tight stops. If this is the case, you should think seriously about if you have enough capital to trade XAUUSD in the first place.
6. Market conditions - If the price is trending up-wards, a tight stop may not be necessary. If on the other hand the price is choppy and has no clear market trend direction then you should use a tight stop loss or not execute any transactions at all.
7. Time Frame - the bigger the chart timeframe you use, the bigger the stop should be. If you were a scalping your stops would be tighter than if you were a day or a swing trader. This is because if you're using longer chart timeframes & you determine the price will be move up it does not make sense to put a very close stop loss because if the price swings just a little, your order will be hit.
The method of setting that you select will mostly depend on what type of trader you are. The most often used technique to determine where to set is - resistance & support zones. These areas give good points for setting these orders as they are most reliable, because the support & resistance areas will not be hit many times.
The guide of how to set these stops that you select should also follow the guide-lines above, even if not all, those which to your gold strategy.
