Trade Forex Trading

What is a StopLoss? and Factors to Consider When Setting Stop Loss Orders

StopLoss is a type of order that is set after opening a trade that's intended to cut losses if the market moves against your open position.

A Stop Loss directive is a pre-established exit point for a trade resulting in a loss, intended for risk mitigation.

A stoploss order is an order placed with your broker that will automatically/mechanically close out your open position when the currency you are trading reaches a predetermined price. When the set level for this stop loss order is attained, your open trade is closed.

Stop loss orders limit losses in trades. They close positions if price hits a level against your trade.

Say you buy EURUSD at 1.3700. Set stop loss at 1.3665. If price hits 1.3650 against you, it closes the trade. Loss caps at 35 pips.

No matter what others say, always use stop-loss orders. They protect your trades without doubt.

Establishing correct stop loss orders presents a significant difficulty in FX trading. Positioning the stop loss too near the entry price risks premature order closure due to minor price fluctuations. Conversely, setting the stop loss excessively far away can convert a minor error in market direction assessment into a substantial financial setback.

Critics often highlight downsides to stop-loss orders. They note that setting one means you lock in a sale at a lower price if your trade turns bad, instead of waiting for a rise.

Critics point out that stop losses can force you out of a trade right before the market shifts in your favor. Many traders know this frustration. They set a stop loss order. Then the price dips to that point or a bit lower. After that, it heads back along the trend they expected. A trade that could have made money ends up losing instead.

Seasoned investors always use stop losses because they are key to having the self-control needed to do well, as stop loss orders can keep a small loss from turning into a very big one. Also, by carefully setting these stop loss orders each time you make a trade, you make this important choice when you are most neutral about what is really happening in the market, since the most unbiased study is done before starting a trade. After getting into the market, an investor tends to view and study the market in a different way because they favor one side, which is the way their trade study points.

Unexpected news can come out of nowhere and significantly affect the currency price: this is why it is so crucial to have a stop loss order. Its best to cut losses early when a trade position is going against you, it's better to cut your losses immediately rather than waiting it to become a large one. Again, if you put your stop orders when you're opening a trade transaction, then that is when you are most unbiased.

A very important question is where to put this stop loss order. In other words, how far below your buying price should you set this stop loss order? Many traders will say to set a maximum loss amount that you will accept, based on your account balance, instead of using indicators to figure out where to set stop orders for the specific forex money pair.

Pros in money management say limit loss to 2% of account value per trade. With $50,000 in funds, set max loss at $1,000 for each deal.

If a trader purchases one standard lot of a currency pair, they should confine their risk to a maximum of $1,000. In this scenario, the stop-loss order would be set at 100 pips, and the trader would maintain $49,000 in their account if the position is exited at the maximum allowable loss. The discussion surrounding risk management is extensive and often integrates with equity management topics.

Factors to Consider When Setting Stop Loss Orders

Most crucial question is how close or how far this stop loss order should be from the price where you opened the FX trade position. Where you set the stop loss order will depend on several factors:

Since there aren't any rules cast and set in a stone as to where you as a trader should set these stop loss order levels on a chart, we follow general guidelines that are used to help put these stop loss order levels correctly.

Some of the general guidelines used to set stop loss orders are:

1. Risk - How much is one willing to lose on a single trade transaction. The general rule is that a forex trader should never lose more than 2 percent of the total account capital on any one trade transaction.

2. Volatility means how much a currency pair's price moves daily. If a currency pair's price usually goes up and down 100 pips daily, don't set a tight stop loss, because you might be removed from trading by usual price changes.

3. Risk : Reward Ratio – This involves estimating the potential risk versus reward. When market conditions and factors are favorable, you can comfortably allow your open trade more leeway. Conversely, if the market exhibits strong range-bound behavior, initiating a trade without a tight stop loss becomes hazardous - in such scenarios, it's best to abstain from the FX trade altogether. If the risk:reward ratio is not in your favor, even deploying strict stop losses will not guarantee positive outcomes. It would be more judicious to seek a preferable trade setup for your next opportunity.

4. Position Sizing: If the volume of the trade executed is excessively large, even the smallest move in a decimal point will represent a significant percentage change. This necessitates setting a tight stop loss, which is more susceptible to being triggered. In most scenarios, it is preferable to reduce the trade size to allow the position more scope for normal fluctuation, thereby enabling the setting of a more reasonable stop loss level while simultaneously lessening the risk of the stop loss order being prematurely hit by price volatility.

Trade Account Equity is important - if your account is underfunded, you may struggle to set appropriate stop-loss levels, as a significant position might require overly tight stop losses. In such cases, reconsider whether you have sufficient capital for Forex trading.

6. Market conditions - A firm halt may not be essential if the price is rising. On the other hand, if the price direction is range bound and there is no evident trend direction, you should either set or use a tight stop or refrain from entering any trades at all.

7. Time Frame - the larger the time-frame you use, the larger the stop loss level should be. If you were a scalping your stops would be tighter than if you were a day trader or a swing trader. This is because if you are using longer time frame and you figure out & determine the price will be move upwards it doesn't make sense to put a very tight stop loss because if the currency swings a little your open position stop loss order level will be hit.

The method you choose for setting a stop-loss order will largely depend on your trading style. The most commonly employed technique for determining where to place stop-loss orders involves identifying resistance and support zones. These areas provide reliable points for establishing stop-loss orders, as they represent levels where the price is unlikely to surpass. Since support and resistance levels are not frequently breached, many traders opt to set their stop-loss orders just above resistance levels or just below support levels.

When setting stop-loss points in trading strategies, adhere to best practices even if specific instructions don't fully align with your chosen approach.

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