The subject of stop losses is vital to every Forex trader. Why? Simply put, the stop loss level is the ultimate level where a trader chooses to accept a losing trade. A Forex stop-loss strategy allows traders to cut their losses when appropriate. It’s necessary because traders use leverage to maximize the potential gains from the Forex market.
We will start our article with a glance at leverage since it is the reason/culprit why we Forex traders absolutely must use stop losses. Then, we will examine some of the rules and potential snags surrounding stop-loss strategies.
Finally, we will look specifically at how trailing stops can boost the efficacy of a stop-loss Forex strategy. Therefore, continue reading to learn all about how to implement the best stop-loss strategy and the ways you can use it to your advantage.
Table of Contents
Forex Stop-loss Strategy: Everything You Need for Trading Success
Forex traders enjoy access to high leverage (the use of borrowed funds to increase one’s trading position beyond what would be available from their cash balance alone). However, leverage can be a double-edged sword with a significant amount of risk involved.
It is a simple business proposition for traders. The higher the leverage, the riskier the trading becomes. Moreover, the riskier a trade, the more likely a trader will end up holding a losing position. Click here to read more about the salaries of a Forex trader.
Traders can access unusually high leverage levels. Anything up to 100:1 is common for Forex traders, and nowadays, the leverage “mania” continues, and some brokers are even offering leverage levels close to 1000:1. Even if you only have $1,000 to trade, you can move up to $1,000,000 worth of capital!
Leverage Is the Risk
Leverage is what makes the Forex business a risky venture. Think about it: If you own currency, are you at risk of a stopout? Is there a need to stop the loss?
When you own the currency, you own it. The risk you run is the devaluation of that currency in opposition to other currencies. You also run the risk of inflation and losing purchasing power in the future, and that is it. Owning and trading your currencies at a 1:1 rate is not as dangerous as other trading strategies.
The critical risk with Forex trading is leverage. Using leverage is a risky business. Even if you use a Forex position calculator, you may still lose money. If you use leverage and do not use a stop loss, you gamble and put yourself at risk of losing all your capital and getting a margin call.
Furthermore, the risk disclaimers are there for a reason. They aren’t just a formality. The lower the leverage, the better, as the expectancy rate of your capital surviving and sustaining any string of losses increases.
With leverage, the game is simple: you need to use it to protect your entire capital or trading capital.
Potential Stop Loss Issues
Stop losses are a valuable tool for any trader. However, because you use stop losses to protect your (trading) capital, you run a separate risk, such as when your stop loss gets hit and you lose your position.
Even if you have the best stop-loss price entry in the world, there is always a chance the market will take it out and go in the direction that you anticipated. There is nothing we can do about that. This is a fact of life and trading.
To reduce risk, traders should find the most logical return to risk/ratio opportunities. Otherwise, these trade opportunities create a positive expected rate of return in the long term.
Another thing traders can do is find the best place for their stop compared to their type of strategy, the structure of the stop market, key levels, the time factor, a trader’s character and psychology, etc. We’ll elaborate more on that later.
What Is a Stop-loss Order, and How Do I Use It?
A stop-loss order, also referred to as a stop-limit order when used for gains, is a type of order that is placed with a broker instructing them to exit a position whenever a security has reached a certain price. Stop-loss orders can be used for Forex, stock market trading, and securities trading.
For example, suppose a stock is currently trading for $100 per share. In order to make sure you minimize the amount of money you possibly stand to lose, you may issue a stop-loss order for $90. If the price drops below this level, your broker will then immediately exit the position (unless the order has been retracted). This means that even in the worst-case scenario, you only lose $10 per share.
Stop orders can be placed in the other direction to help you “lock in” potential gains on a given security. In this example, when a stock is trading for $100, a trader issues an order at $130. This creates an optimistic situation where the trader is yielding a 30% return on their investment.
Because the high exit point is three times away from the current mean as the low exit point, the reward: risk ratio in this situation is 3:1. The ratio can be easily adjusted according to your risk preferences and objectives.
Moreover, the purpose of using stop orders is to manage your exposure to risk and decrease the amount of attention you need to be paying to the market. They can be easily issued with any legitimate broker. Read more about how to choose a broker here.
The Three Rules of Stop Losses
The rules are:
- Always trade with a stop loss to protect yourself.
- Define your own stop and define before you enter the trade.
- Never move it unless absolutely necessary.
Checklist for a Forex Trader
When it comes to Forex trading, everything needs to be prepared. A famous Forex expression is to plan our trade and trade our plan. Here are some crucial aspects every trader needs to have in their FX trading plan:
- Plan your trade before you enter.
- Use hard stops, even if you have a soft stop.
- Don’t exaggerate with the leverage levels, and try to minimize them.
- Use adequate stop-loss sizes that realistically match your risk-reward preferences.
- Trade with sufficient reward-to-risk ratios compared to your win, break-even, and loss percentages.
- Stick to your plan after the trade begins. Take profits as planned and never increase the size.
Stop Losses Are a Sensitive Topic
Traders should treat their stop-loss strategy with care because improperly set stop losses can cause significant losses. Once exercising a stop loss, there’s no turning back. You lose your position. Therefore, it can be tempting to commit an action no trader should: moving the stop.
Most traders experience their stops getting hit at some point, after which they exit their position, and the market reverses. This is an unavoidable aspect of trading, and traders shouldn’t take positions if they can’t handle the risks associated with them. Make sure to read these common mistakes around stop losses and coping with the loss of money after a bad trade.
Another thing that can happen is that the trade barely survives. After hours and hours of waiting, the trader decides to exit the position, only to see the currency move impulsively in the right direction. All traders have encountered this feeling, and it is a rough experience. It is demoralizing, and it can shake traders’ confidence.
It does not matter how tempting it might be. Once you have a game plan, risk-tolerant traders stick to it. The temptation to ease the pain of a loss is overwhelming, but whatever the psychological issues that emerge, don’t change the stop. It is ok to have a loose stop as long as it fits your strategy setup. Simply put, Forex traders must have a stop loss, but they have to stick to their stop-loss strategy.
Using stop losses to your advantage comes down to picking a strategy and sticking to it. As a Forex trader, choosing a strategy comes down to understanding your options. There are a few subsections of stop-loss trades that can help you maximize your profits, such as trail options. The following section details trail stops, which are one of the options available to Forex traders.
Using Trail Stop Options to Enhance the Efficacy of Your Stop Loss
Using a trailing stop is one of the most effective ways to enhance your stop-loss order. Trailing stops, unlike most stop-losses, are orders where the stop-loss price isn’t fixed at a single dollar amount. Instead, trailing stops set a percentage or dollar amount below the market price.
When the price on your position increases, it drags the trailing stop along with it. If the price stops rising, the new stop-loss price remains where the market carried it. Using trailing stops automatically protects your downside, locking in profits as the price reaches new highs.
When does a trailing stop make sense? Is it better to use a take profit and a fixed reward to risk (R:R) ratio?
Trailing Stop-Loss VS Take Profit Video
You also need to ask yourself the following questions when considering when implementing a trailing stop stop-loss.
- Do you use trail stops?
- Have you tested the trail stop effectiveness before using it?
- If you do not use it, why not, and what do you think is better?
Trail Stop Options
There are various ways of implementing a trailing stop, such as:
- An immediate trail stop in the same time frame.
- An immediate trail stop on a higher time frame.
- Trail stop after a target has been hit.
- A mix of hard take profit and trail stop.
- Increasingly tighter stop loss when in higher R:R levels.
- Discretionary (open for later decision: no take profit or trailing stop).
Various methods can be used for a trailing stop, including:
- Bollinger bands.
- Swing high, swing lows.
- Support and resistance.
- Fibonacci levels.
- Parabolic SAR.
- Moving averages.
Trail Stop Balance
The advantage of the trailing stop is that a Forex trader lets some of their winners run and cuts some of their losses short. This is a compelling concept in Forex trading, where increasing one’s average R:R win versus average R:R loss is a pivotal part of becoming profitable. Here are some important notes that deserve attention.
Testing the Trailing Stops
Traders need to test their trailing stops for their efficacy and profitability before implementation. A seasoned forex trader tests how various trail stops fit their strategy for different trades (typically a couple hundred) to gain insight into whether the trailing stop is more effective than a TP.
It is essential to review the long-term data such as the profitability, drawdown maximum, average win, average loss, number of maximum losses, and the number of victories that win more than the maximum loss compared to total wins. This information provides details on which system has the best balance.
Don’t Overthink it
Avoid over-analyzing data. This part of Forex trading deserves time and attention, but every trail stop and hard take profit will have certain disadvantages and advantages. Forex traders need to accept that one particular method will never be perfect. There will always be examples where a specific type of trail stop works better than the other.
A note on trailing stop psychology:
A chosen trade management method must always be in sync with trading psychology. As with any other trading strategy, Forex traders deciding on trailing stops need to balance their strategy, risk management, money management, and mental biases.
The Advantages of Trailing Stops and Take Profits
Both the trailing stop and the take profit levels have certain advantages and disadvantages.
Benefits of a Trail Stop
Here are the benefits of using a trail stop:
- A trailing stop allows the market to decide how far it wants or does not want to go instead of Forex thinking for the market. The Forex trader thereby “rides the tide” and “goes with the flow.”
- Trail stops eliminate some of the fear tied to losing capital, resulting in more evident trading strategy approaches. The trailing stop helps protect the trading capital by locking in more minor losses.
- 2:1 R:R back down to a complete loss. This idea could create serious problems, such as a Forex trader “clicking out” a trade earlier than planned.
- A trailing stop allows for massive wins – occasionally. These huge wins can spike traders’ equity curves to new levels.
Benefits of Taking Profit
Here’s why you should set take profit levels:
- Take profits have a smooth equity curve compared to trail stops because the answer is always simple: either a win or loss. Trail stops can create smaller wins, smaller losses, and occasional bigger wins, which creates a more volatile equity curve.
- The reward-to-risk ratio is easier to calculate with a take-profit strategy because the potential reward is a given.
- A take profit requires less trade management time. With precise levels where a Forex trader wants to exit the market for a loss or profit, it’s easier to create a “set and forget” mentality. Trailing stops require attention to the adjusting market.
When to Use and Avoid Trailing Stops
Deciding when to use trailing stops comes down to knowing your strategy and contemplating the best approach. An intra-day trader might not want to use a trailing stop because they prefer closing their position before the close of the trading day. They might also give up too much profit compared to the expected daily range.
While swing traders don’t have the same time constraint as intra-day traders, they still need to create a time-sensitive trailing stop because they cannot monitor the markets all the time.
Because of this, swing traders should either create a trailing stop, which can be monitored by reviewing the charts a couple of times a day or trade in a group of traders who constantly check the positions.
Also, there is the question of which stop-loss strategy traders use. A Fibonacci strategy uses Fib levels as a take profit level. A break-out strategy, however, could be suitable for a trailing stop.
Then again, the take-profit level could be better suited for a range strategy. A reversal trade might want to incorporate a trailing stop after reaching a certain profit. In contrast, a trending trade setup could seriously benefit from a trail-stop loss as the price extends in one direction.
The Big Question: Where to Put the Stop Loss?
The example of implementing trail stop orders to increase efficiency on your stop-loss brings us to another critical decision: where to set your stop-loss. There are two primary problems to consider:
- You can place the stop too close to the market. A vital sign of this is whether you see many stops initiating, after which the trade materializes as you originally planned. The added risk that wider stops create can be compensated by reducing the lot size.
- In other cases, you might hit your profit targets but realize that your reward does not sufficiently compensate for your risk. In those situations, you should consider tightening your stop loss size.
However, there are other elements to correctly placing your stops, such as:
- Currency pairs vary in terms of volatility, spikes, and average distances daily. It is recommended to study the currencies you regularly trade.
- The type of stop-loss depends on your strategy. Stops can differ depending on the strategy you choose. For example, trending strategies are different from ranging strategies.
- The time frame you use for trading affects your stop placement. Using a shorter time frame requires traders to use more minor stops to allow a decent reward compared to risk. Stops for such a scalp/day trade should differ from that of a trade taken for a swing based on the daily or longer timeframes.
- Study significant Fibonacci levels, key resistance, and key support levels in higher time frames.
- Your trading character and trading psychology are essential to consider. Can your mentality handle a small stop? Are you able to live with a 150-pip stop loss?
- How does the structure of the market look? Is the currency chopping and going sideways, or is there a clear pattern visible?
Feel free to read more about Forex chart patterns here.
Levels to Consider
Here are some concrete tools that you can use for your trading to actually place your stop. We are sure there are more examples, but here are a few of them:
- Fibonacci retracement levels.
- Tops and bottoms.
- Swing highs and swing lows.
- Candlestick highs and lows.
- Invalidation levels of the Elliott Wave Theory.
- Consolidation zone/resistance – support areas.
- Trend lines.
- Trailing stops.
- Technical Analysis
Stop-loss Trading Strategy
Stop-loss trading is one of the most essential tools in trading stock, Forex, commodities, and cryptocurrencies. If you want to have longevity in the markets, then you absolutely need to use a stop-loss trading strategy. Throughout this section on stop-loss trading, you will learn how to deal with the fear of losing money by using a stop-loss order.
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When you’re entering into a trade, you’re automatically overwhelmed with a lot of negative emotions due to the risk of losing money. It also triggers the receptors in the back of your mind and throws you out of balance. Stop-loss orders make it easy to avoid the risks of trading psychology and capture your gains.
This, in turn, will eventually lead to bad trading behavior and taking unnecessary losses. Therefore, trading with a stop-loss order will bring more composure, rationality, and peace of mind.
What Is a Stop-loss Order?
A stop-loss order is a risk management tool designed to close an open position at a predetermined stop-loss price. The stop-loss price is just the value you decide you’re wrong on your trade.
If a stock, for example, costs $100, a trader might issue a stop-loss order at $90. Moreover, if the stock loses 10% of its value, dropping to $90, the stock will automatically be sold. While the trader ends up with a losing position, they avoid losing even more money (exiting before the stock drops to $80).
Regardless of the market traded, the stop-loss price can be determined by employing technical analysis tools such as:
- Support and resistance.
- Above and below key price chart patterns.
- Pivot points.
- Market structure.
- Technical indicators.
Whenever you buy an instrument, your stop-loss is always placed below the current market price. Inversely, your stop-loss is always placed above the current market price whenever you sell an instrument.
A stop order is an effective tool that should be part of any risk management trading strategy.
Here is a real-world example of a stop-loss order in action:
If you bought Apple shares and set your stop loss at $225, your order instructs your broker to sell the stock if the price drops to $220.
Stop loss trading is like an exit plan. Once a stop-loss order is exercised, you will no longer own the asset you are trading. Stop-loss orders allow you to control your exact level of risk exposure.
Stop loss trading is managing risk. Unsurprisingly, many billionaire hedge fund managers see themselves first as risk managers and only after that as traders.
You’ll never succeed in this business if you don’t learn a good strategy to set your stop loss. Making money in Forex is easy. However, the hardest part is to manage risk appropriately.
Let’s see how stop-loss orders work in any market or time frame. Here is the list of orders that can be used in Forex trading:
- Trailing stop loss order.
- Stop market order.
- Sell limit order.
- Trailing stop limit.
- Stop-loss order.
- Buy limit order.
How to Become a Forex Stop-loss Calculator
Are you wondering how to use a stop-loss order? These trading tools are essential for all trading strategies. A stop-buy order should be established long before you enter into a trade.
This is essential. Why? Because it can assist you in calculating how much money to risk per trade.
For example, if you know that your SL is 100 pips or 20 ticks below your entry price, you will not want to risk as much capital as if your stop-loss is only 20 pips or five ticks below your entry.
The con of using stop losses is when the market suddenly gaps below the stop-loss price. When this happens, you may end up trading below the initial stop-loss order.
This is more common with stock trading. To avoid gaps, you can use a stop-limit order, which guarantees your order to be filled at the stop-limit price.
Now, we’re going to show you how easily stop losses are calculated:
For example, let’s say that you want to buy USD/JPY at an exchange rate of 109.00. Using technical analysis, you reached the conclusion that an ideal place to hide your stop loss is below the 200-day moving average at 108.60.
You can calculate your stop loss by simply subtracting your stop loss trigger price from your entry price. Then, our stop loss size is 50 pips (106.00 Entry – 105.50 SL = 50 pips). Next, you’re going to discover the importance of using a stop-loss order.
Why Are Stop Losses Important?
A stop loss is important because it will protect you from losing more money on your trades. By using a protective stop loss, you know in advance how much money you could lose on each trade. This can be extremely helpful in implementing sound risk management strategies.
In this step-by-step section, you’ll learn how to build a trading risk management strategy. The main goal is that a stop loss minimizes losses.
Additionally, a stop-loss order can help you hold on to your trade longer and grants you more time to profit from a trade. There is no such thing as the Holy Grail in Forex trading (stock trading, commodity trading, options trading, or cryptocurrency trading). It’s humanly impossible to win 100% of the time unless you have a time machine.
That’s why you need to master stop-loss trading to protect your trades when things go wrong. For example, the grid trading strategy is a complex system that requires some trading experience. However, even if you’re the most successful trader in the world, to properly manage a multitude of open trades, you need to do grid trading with stop loss.
Is your stop always getting hit only for you to see price action reverse and go back in the direction of your original trade? Well, I’m pretty sure many traders have experienced this. When this is the case, you may want to consider adjusting your current trading stop-loss Forex strategy.
Do you want some help to prevent your stop from getting hit and improve your trading success?
Below, we’re going to share two simple tips for setting stop losses.
Two Tips to Avoid Getting Stopped Out
Navigating the volatile world of trading requires not just skill but also strategic foresight. Here are two indispensable tips to help you avoid the frustration of getting stopped out prematurely.
Tip #1: Place an Entry Buy Where You Want to Place Your Stop-loss
The stop-loss tip number one is to place your entry where you want to place your stop-loss. We want to challenge you to try using this “best stop-loss strategy.”
Often, traders lament about their stop loss getting hit, and then the price immediately reverses to go back in their favor. How do we avoid that?
Well, the truth about stop-loss nobody told you is simple:
Try reversing conventional thinking and placing your entry where your stop loss originally would have been. This looks something like this:
Flipping your entry with your stop-loss order is one of our secret stop-loss trading strategies. By using this stop loss secret, the “new you” will be getting into a trade as the “old you” would have been getting stopped out.
Flipping that psychology and putting your entry where your stop loss originally would have been will give you a much higher success rate in your trades. Also, you’ll start buying professionally by using this secret stop-loss technique.
Tip #2: Allowing the Trade to Work in Your Favor
Give your trade room to work in your favor and stop moving your stop loss to break even (BE).
Did you know that 70% of losses among retail traders are caused by prematurely moving your SL to break even? That’s reason enough to stop trailing your stop loss as soon as you see little bits of profits on your open trades.
By allowing your stop loss to stay unchanged, you can adhere to your stop-loss Forex strategy and see what happens next.
Now, you can enjoy more profits! Let’s look at some examples of placing strict stop losses. Don’t expect anything conventional in our approach to stop-loss trading. We try to challenge conventional wisdom.
Options Trading: The Best Stop-loss Strategy
If you want to find amazing trading opportunities that most traders overlook, make sure to learn our best stop-loss strategy for options trading.
This section will cover everything you need to know about call option vs. put option. If you don’t know what these options are, let us introduce you to options trading.
Options are a great alternative to using a stop loss. Let me explain why.
You can control the risk by opening an option trade either in the underlying instrument you’re trading (for futures) or on other related markets. Options trading has many advantages over traditional risk management strategies.
For example, in fast-moving markets, you can encounter slippage. Many brokers don’t guarantee stop losses. In essence, this means that they don’t promise you’ll get the desired stop-loss price once triggered.
However, using options instead of stop-loss, you can’t lose more than the strike price. If you haven’t realized by now, this is similar to hedging strategies.
For instance, if you go long crude oil futures at $55.00 and set your stop loss at $54.50, limiting your loss. However, if the next day, crude oil price gaps lower at $54.00, your stop loss trigger price will be $54.00.
This will lead to a bigger loss than you initially anticipated. So, do you want to know how to set stop loss like a professional trader?
If you buy an option with a strike price of $54.50 instead of a stop loss, you can’t lose more than the strike price. You have to pay a premium to buy an option, but it’s worth paying an extra fee if that’s going to reduce your potential loss.
The good thing is that you can buy out-of-the-money OTM options, which typically are less expensive than in-the-money ITM options. Usually, hedge fund managers use options such as using a hard stop-loss.
Secondly, between options vs. stop loss, options trading allows the trader to better navigate ranging markets. In consolidation, you can be easily hit by a whipsaw or stop hunting activity. It becomes an easy target if you place the stop at the wrong place.
By having options set in place instead of a stop-loss order, you can reduce the negative effect that comes with range trading. Even in the trading market, an option is a better alternative to a trailing stop-loss Forex strategy.
The swing trading strategies often use a trailing stop that can be easily triggered. Again, options trading provides a better way to manage your risk and secure profits.
Conclusion: Stop-loss Forex Strategy
If you fear that your broker will hunt your stop loss, this will prevent that from ever happening again. You can avoid being stopped from your trades too often by simply following the Forex stop-loss strategy tips highlighted throughout this guide.
These tips can be applied in every market (stock market, Forex, cryptocurrencies, commodities, etc.). The more you practice as a trader, the easier it will be to effectively implement stop-loss orders and other trading mechanisms.
To succeed with options trading, look at trading the same way as professional traders. Through this stop-loss technique, you can better control the risk and protect from volatile markets, ranging markets, and fundamental shifts in the supply and demand equation.
Forex traders can use stop losses to mitigate the risk caused by high leverage. However, to minimize the risk associated with lost capital, traders must apply stop-loss strategies in a savvy manner to their trades. Doing so requires a thorough analysis of factors such as Fibonacci retracement levels, candlestick highs and lows, and others.
If you’re looking for the best stop-loss strategy, the trailing stops method might be the one you’re seeking. Trailing stops represent a valuable strategy for Forex traders looking to maximize their stop loss efficacy. Nonetheless, there are other strategies, such as taking profit, that can accomplish the same end. The most successful Forex traders understand how to use these tools when appropriate.
Trading Strategy Guides is committed to giving traders the tools they need to create sustained growth and value. Use the following list of articles for further reference on stops and how to use them to your advantage.
Reward to risk:
- Maximize profits and minimize risk.
- Minimizing risk, maximizing reward.
- Using 2:1 R:R.
- Zero To $1 Million Forex Trading Strategy.
- Parabolic Sar Strategy.
- Exponential Moving Average Strategy.
- ATR Strategy.
- Forex Trading – Setting Realistic Income Goals.
Ok, folks, that’s it for today. I hope you enjoyed it. If you liked this article, please leave a comment in the section below.
You can find the second part of the article here, which will give you practical examples where you can actually place stop losses using the tools mentioned above. We also have training for trading Forex without setting stop losses in our best hedging strategy article.
Thank you for reading!
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