Financial markets can change in an instant, and Forex is no different. Huge gains can be made, but equally so, massive losses, which can prove devastating. Stop loss is one major tool at a trader’s disposal to try and prevent excessive loss.
What is a stop-loss?
A forex stop loss is essentially a protection against volatile movement in the market, in particular when that movement is contrary to the initial trade. This is done by applying a stop loss level before opening a trade. By specifying the number of pips away from the entry price you can be flexible with how much risk you want to take. This is basically a tripwire that when your trade crosses it, your broker will close the trade. This can significantly reduce the damage in long term trades when you might need to be away for several hours but is commonly used with short term trading also.
What are the advantages?
The advantages of stop-loss are plain to see. As sure as you might be about trade, nothing is definite. It provides a safety net of sorts that stops a bad trade from becoming a truly terrible trade. It also gives you a higher degree of freedom because it means you won’t have to constantly monitor the trade.
What are the disadvantages?
A lot of this will depend on your trading style and strategy. Setting a stop-loss that is too low (too few pips) could trigger a stop when the price is naturally fluctuating. In theory, you could be faced with the prospect of a price dipping below your stop-loss limit, then rebounding strongly after. Meaning your broker would have closed the trade at a loss, rather than remaining open and taking advantage of the gain.
How do I do it?
There are a number of ways to set a stop loss, here are three of the most common:
The most common way is to simply set static stops before the trade has been opened, and can allow traders to set up a one to one risk to reward ratio, or more should they wish. Setting a 50 pip stop to prevent losses going any further, while having a 50 pip limit order going the other way.
Manual Trailing Stops
For those who crave as much control as possible but still want a rough guideline of safety, this could be for you. It is possible to move stops while the trade is open. If a trade is moving your way, you can adjust the stops as you go to keep pace with the gains. This would prevent a sizeable swing from profit to loss.
Fixed Trailing Stops
Similar to manual trailing stops, but here the stops can be set to increase incrementally as your gains do. For example, a trader could set their stops to increase for every 10 pips in their favor. This gives more flexibility because it can allow your stop to move almost in conjunction with your gains.Tags: finance, finance eduction, fixed, market, trading