Trading Forex for a Living

Stop loss orders are highly recommended because they are easy to use and helps protect the trader from excessive risk taking and losses.

What is it?

Stop loss order is an order gets executed to buy or sell once the asset reaches the preset price. The key usage of this is to reduce the amount of loss on a position.

Suppose you bought 1 micro lot of GBP/USD at 1.5810. According to your risk management strategy, you may place a stop loss at 1.5800. If market moves against you and price drops to 1.5800, this order gets activated and the brokerage will sell your lot at the current market price. This may or may not be 1.5800, but it should be close, barring extremely volatile conditions.

Why should I use it?

You don’t have to monitoring the market the whole time when you have open positions. There will be times when our time and attention are required elsewhere, or when you have a few trades to monitor all at the same time. Regardless of what situation, planning to monitor with your full attention is not practical, so protect your downside in your forex trades in advance.

The fact that a stop loss needs a price for it to be activated also means that you would have to put in good thought to your loss exit point. Sure, you are optimistic and raring to go before you book a trade, but trading is all about probability and there is a probability that the market will move against you.

In addition, it is best to keep your trading as automated as possible, so as to minimize any chance of your emotions overriding your rational decisions.

What’s the disadvantages of doing so?

Once you have taken a position, the market can fluctuate and cause you to get stopped out before it has the chance to develop further. You could be right about your trade, but the volatility and your stop loss order had prevented you from taking your profits.

Instead of avoiding a stop loss order, the correct solution is to pick a trigger price that caters for the currency pair’s volatility while making sure your downside risk is contained. This also means you need to have some idea about the pair you are trading and what its historical volatility is, before coming up with that stop loss price.

Variant – Trailing Stop

Stop loss can also be used to lock in your profits. Instead of keeping it static at a single price, you move it according to market gains. If you are going long, you move the stop loss upwards; conversely, if you are shorting, you move the stop loss downwards. With a trailing stop, you are virtually guaranteed of some profits.

Consider our earlier example again. After entering the position at 1.5810, it starts to gain and at 1.5820, you can move your intial stop loss to 1.5810. That’s your entry point, which means now even if you get stopped out, you may not lose any money. This essentially becomes a zero-risk trade.

Finally,

There is no hard and fast rule about where you put your stop loss and trailing stops. Adhere to your risk management strategy, follow the trend, read the technicals, and practice.