Stop-Loss is the main way to protect a trader from large losses. It refers to the obligatory tools that traders must have, but the specific conditions for placing a Stop-Loss in Forex are determined according to the knowledge and experience. Today we will learn what the Stop-Loss is, what is Trailing Stop-Loss in Forex, as well as have a look at different strategies on how to set it
What is a Stop-Loss?
Stop-Loss in Forex trading is a limited order, which closes a position when a specific condition is reached. To better understand the meaning of the term, let's look at an example.
Suppose you are trading the EUR/USD pair and assume that there should be an uptrend after entering the market. If the trade is planned to be closed within 10 minutes, it is quite logical to observe the quotes changes independently. But with longer terms, you may simply not be able to spend all the time at your computer.
In fact, this is not necessary. You can use a Stop-Loss order and set the lower threshold of the trading corridor. If the trend suddenly makes an unexpected reversal, the trade will close automatically as soon as the quotes drop to the level of your choice.
In this case, the losses from the unsuccessful trade will be minimal. And, even if you do not personally control the position, no irreparable consequences will occur. The possibility of setting Stop-Loss is provided in all trading terminals.
It would seem that the use of Stop-Loss should completely offset the losses of traders or at least reduce them to 0.5%-1%. But in practice, it often happens that the use of the tool, on the contrary, prevents traders from fixing the profit. It happens due to incorrect use of limits. We will tell you how to do everything correctly.
Why Are Stops Important?
Most experienced traders prefer medium and long term strategies rather than spend several hours a day in front of the computer. Therefore, the Stop-Losses are set at the maximum allowable level of losses, which is determined in advance within the framework of their own risk management. The task of the stops is to minimize the risks. And this is especially important in short-term trading, as traders with this specialization are much riskier than medium and long-term. The presence of exposed stops will protect a trader from losing all the deposit in the case of technical malfunctions. For example, if communication with the terminal is suddenly interrupted and you do not have time to send an order to the broker to close the trade, then instead of it, it will make a pre-installed stop. And you do not need to be nervous and worried. But the absence of a stop in such a situation will bring a significant loss.
Experienced traders advise determining the correct level to calculate an acceptable risk/profit ratio. If it is difficult or impossible to locate such a level, there is no point in entering into the market - it will be too risky. In medium and long trades, the stops are usually placed well beyond the current price level (from 500 points). And this is possible with a solid deposit. If you have a small amount on your account, either enter into a trade with a small volume or abandon the idea. Set your stops in the safest places in terms of risk (relatively, of course) - using strong levels of support and resistance. A correctly placed Stop-Loss will significantly increase your chances of a successful trade.
Stop-Loss: Setting Static Stops
As we have mentioned above, the size of the Stop-Loss is a reflection of the amount that the trader is willing to risk in an open trade. When entering the market with the whole deposit, the risk is, of course, 100%. Ideally, the recommended risk level should be 2-5% of the deposit for each trade.
For example, a trader's deposit is $5000. The trader has set the maximum risk level of 5%. Accordingly, the loss per trade should not exceed 5000 x 0.05 = 250 dollars.
Next, you should evaluate the ratio between the Stop-Loss size, the price of one pip, and the position volume. Let's say, the trader has calculated that when opening a position at a given point, the Stop-Loss will be located 50 points from the entry point. The price of one point will be 250:50 = $5. Taking into account that at the position size of 1 standard lot price of 1 point is $10, we get the recommended position volume of 0.5 lot.
The above example is optimal and does not take into account such a psychological factor as greed. Unfortunately, many traders, in pursuit of profit, trade the whole lot with a deposit of 1000 dollars. Accordingly, we are not talking about any risk management or calculations here.
When placing Stop-Loss orders, you should remember one more very crucial detail - spread.
For example, a long position in the EUR/USD pair with Stop-Loss 1.1846 and Take-Profit 1.1926 is opened. The spread is 2 points. Accordingly, Take-Profit will trigger when the price reaches 1.1928, and Stop-Loss - when the price reaches 1.1848.
An example is given for a fixed spread. For floating spread accounts, it's a little more complicated than that because the size of the floating spread can increase several times during the release of critical economic data or fundamental events.
Stop-Loss: Trailing Stops
Knowing what is trailing Stop-Loss in Forex is another crucial thing to learn. It represents the algorithm of Stop-Loss order management without active trader participation. Trailing Stop allows the Stop-Loss level to move after the price if it moves in the right direction.
Typically, a Trailing Stop is used in trend-following strategies when it is necessary to maintain existing profits, although its use is possible with any trading tactics.
For example, after the price bounces off an uptrend support line, you open a long position by setting Take-Profit at the resistance line and Stop-Loss below the local minimum. As you know, the market is volatile. Let's assume that due to some factors the price didn't reach your Take-Profit order. The next time you look at a trade, instead of the expected profit, in the best case, you will have time to fix the last of it, in the worst case, you will get a Stop-Loss.
Let's say you opened a long position on the EUR/CHF currency pair and set the Stop-Loss and Take-Profit orders. Then the price started to rise, bringing you some paper profit. You decide that if the price reverses more than 30 pips, you will have to close the position and set a Trailing Stop at 30 pips. In this case, until the price goes up 30 pips or more, there will be an old Stop-Loss order (which you set initially), and then the terminal will automatically start moving the order every time the price moves up. That is, when the price goes up 30 points, the Trailing Stop will immediately drag the Stop-Loss order to breakeven (30 points from the current price). When the price goes up to 35 pips, the trailing stop will drag the Stop-Loss order to a level plus five pips, etc.
Of course, a Trailing Stop will only drag a Stop-Loss towards your profit, that's the point. And when the price reverses and passes from the current local extremum to the loss side of the specified number of points (in our example, 30 points), the position will close in profit.
Note that if you use a Trailing Stop, the Stop-Loss order may not be placed, but the Trailing Stop will set the Stop-Loss itself at the opening level of the trade after the price has passed in the right direction, the set number of points. However, we do recommend that you place a Stop-Loss when you open a position because no one is immune to force majeure, and the price may reverse without going the required distance for the Trailing Stop to trigger.
As you can see, there is nothing complicated in using the Trailing Stop on Forex. Using a demo account, every beginner trader can find the optimal levels for his trading tactics, thus turning it into another tool for profitable trading.
Stop-Loss Strategies
The skill of setting Stop-Loss in Forex is one of the most important aspects of trading since it determines the results of each position. Hence you will need a good strategy of placing Stop-Loss in Forex. We offer you some of them, have a look and see if any of them is working for you.
- Stop-Loss Strategy: Inside Bar And Pin Bar
Let us quickly go through inside bar and pin bar strategies, so we are on the same page. Of course, the location of Stop-Loss is fully determined by the applied strategy. Even though it is all up to you, some moments are still to be taken into account.
If you are using the pin bar strategy, pay attention that it is better to set a Stop-Loss right after the pin bar`s tail. And the direction of this bar makes no difference - it can be both ascending or descending. Consequently, the position opened following the pin bar, it nulls in case the Stop-Loss is triggered. Do not be upset if that happens - it is not good or bad. It just means that the market entry was not that good.
As for the inside bar trading strategy`s Stop-Loss approach, there are two ways to set it. The first variant is to place the Stop-Loss behind the inside bar's high/low. And the second one is behind the main (mother) bar's high/low. Usually, traders prefer to use the last option since it is considered to be safer.
And here, same as in the pin bar strategy, once the price triggers the Stop-Loss, the inside bar position setup becomes null. It is known to be better simply since it lets traders stay longer in the market due to the more "space" between the price at which you open the trade and the Stop-Loss.
Speaking about the inside bar strategy and how to set Stop-Loss there, we cannot but mention that some traders may find it beneficial due to the more acceptable risk-reward ratio. Regardless, there is a serious advantage of this approach - there is a risk of being stopped out without getting a chance to get some profit. Therefore, we can say that this Stop-Loss setting entails more risks due to less "space" between the opening of the trade and the Stop-Loss. Note that the Stop-Loss setting should be determined by your strategy, risk appetite, and the asset traded. Let us now move to Stop-Loss strategies to make sure you have a deeper understanding of the matter.
'Set And Forget'' Or 'Hands Off' Stop-Loss Strategy
Another Stop-Loss placement strategy is called ''Set and Forget'' or you can find it somewhere online as 'Hands Off'. The point here is ridiculously simple - set the Stop-Loss order and let the market do the job. The 'Hands Off' approach retains the Stop-Loss at a safe stretch, reducing the odds of getting Stop Out.
Moreover, using this strategy, you prevent yourself from emotional decisions since you will not do anything once the Stop-Loss is placed. And, of course, it needs you to perform only one action, one simple action.
On the other hand, there are some drawbacks too. The most significant and the most expensive of them is the highest level of acceptable risk. Bear in mind that whatever is the amount you are going to risk per trade, the risk of losing it is there from the time you push the Sell/Buy button and right till the time the trade is closed (either by Stop-Loss, Take Profit or Stop Out).
Likewise, you do not have an option to protect your trading account balance further. Another trap is that employing a 'Set and Forget' or 'Hands Off' Stop-Loss placement strategy can entice you to shift your Stop-Loss. Setting the Stop-Loss at one level can be emotionally difficult for even the most experienced trader. Thus, we cannot say that this strategy is the best option for setting the Stop-Loss, still, it's good for you to be aware.
Stop-Loss Strategy: The 50% Stop-Loss
Even though the underlying approach is meant to reduce the trading risk involved in two, do not expect it to be exactly 50% less. The very idea here is that the trader intends to get the insight of the amount that is needed to be "saved" during the trade. As an example, we can implement this Stop-Loss strategy in the abovementioned pin bar. Let's say you open a position by an ascending pin bar at the market close. On the next day, the market closes higher than the opening price of your trade.
Consequently, as an alternative for exiting the market or moving the Stop-Loss to a breakeven - you will be able to make use of the day's low to conceal the limiting order. It allows you to decrease the risk twice, but still uses a price action level that is the prior day's low. Of course, we have to mention that in case the price breaks the low of the previous trading session, it will make sense to exit the market and close the position.
Conclusion
The level of your losses directly depends on the moment you close the losing trade. The process is easy to automate with a Stop-Loss. It is a simple but effective trading tool, which should be in the arsenal of each trader. Without it, you risk losing a lot of money in a trivial situation.
However, you should not turn your head off and fully rely on this tool. Always carry out manual control of trades, check the quotes movement, and make corrections to the orders during the trading process. Only with this attitude will you be able to achieve success in trading.
