We are going to explain why it’s critical to use a stop loss on all your trades whether you’re a day, swing or even a long term trader. Although, it’s classed as an additional feature on your trading terminal (portal where you execute your trades e.g. Meta trader 4 or TradingView). Using a stop loss will certainly help you to manage risk by limiting potential losses. It’s always better to look at your trading like percentages; you’ll have your winners and there will definitely be losses. Using a stop loss or stop order will limit the maximum amount you’re willing to lose on a particular trade and the impact it makes to your trading account. Let’s keep things simple here: managing risk means managing your potential losses i.e. ‘Risk’ Management means ‘Loss’ Management.
What is a ‘Stop loss’ or ‘Stop Order’?
Scenario: Let’s say you’ve done all your analysis and you’ve spotted an opportunity to go Long(Buy) on EUR/USD. As with any trade setup, you would have an entry price which you can also pre-set manually and an exit price (take-profit). Both price levels can be entered on any broker terminal, be it Metatrader 4 or Trading View. Just to note, for ‘shorting a currency pair’ or selling a currency pair, your entry price will obviously higher than your exit and vice versa for long (buy).
Now, everything is looking great so far, you’ve executed your trade based on your bias and analysis. All of sudden the market drastically turns against you and starts to shift the other way. Maybe this is because of a major Fundamental announcement which does not favour the Euro against the dollar.
What do you do now? Many traders panic in this situation, especially ones who haven’t placed a stop loss or who don’t know a thing about Risk Management.
Definition- A ‘Stop loss’ is a predetermined price level: where in the event that a trade doesn’t favour one’s bias or trading analysis, it is then cancelled by your broker incurring a specific loss. In other words, when you get it wrong (YOUR TRADE) the stop loss ensures you don’t lose beyond that specified level. For shorting or selling a currency your stop loss will be at a price higher than your entry price and for longs or buying a currency pair the stop loss will be below your entry price. The illustration below shows the red zone representing the area where trade will be in loss and the stop loss level price at 1.13868.
How to place a stop loss order?
The image below shows a stop loss order example via Tradingview. The example is of a long trade execution quoted for EURUSD at 1.15709. Tradingview and Metatrader4 are amongst the easiest and most popular terminals for executing trades. However, there are webtrader versions like the XTB’s xtrader5 which is also very popular and user friendly. It might be useful to check if you can sync your broker account with tradingview, this will only be applicable if your broker gives permission.
As shown below, you can either enter price of your stop loss or the desired PIP amount. If you enter a price it will automatically calculate the PIP amount you are risking, 50 pips in the case below. Once you execute trade you can always adjust your stop loss amount as long as your trade is in play. A good practice is always to fix your stop loss because it creates discipline when it comes to long-term risk management.
Why use a stop loss to prevent losses to your trading?
As the saying goes by the famous hedge fund manager Paul Tudor Jones, “Don’t focus on making money; focus on protecting what you have.” Protecting your capital should be your number one focus; if you don’t have that mind-set of preserving your capital then you’ll end up depleting your trading account. You may be asking what is the best stop loss strategy? There isn’t a particular one but you must have an overall risk strategy which you consistently implement over the long-term.
The famous one percent rule could be great place to start; that means you risk 1% of your capital on each and every trade. Let’s say you lose your first trade; your capital account will be down to 99%. This means you next trade should 1% against 99%
A day trader, may consider to risk half a percent per trade as they may have more than 10 open trading positions on any given day. Therefore, the maximum risk is at 5% on their capital.
As Forex CFD trading is leverage trading (i.e. profits & losses are amplified), it all boils down to the individual trader and their risk tolerance. If you can tolerate risking/losing 3% per trade, then obviously you will stand to profit more based on risk/reward.
Brokers offer better features: Guaranteed Stop Loss
Sometimes your trades may go beyond your stop loss price by a couple of pips thus increasing your loss. Brokers refer this as ‘slippage’ and it mostly occurs during times of high volatility. Brokers such as XTB & EasyMarkets all have the guaranteed stop loss feature that will enable you to be certain of knowing that your trade will terminate at your Stop loss price level.