Stop losses are essentially employed by forex traders to avert financial losses when entering positions in the market. These are orders that are placed in the forex market to close s position that is live in the market. Investors who employ a set strategy will usually place their stop loss just as they initiate a position. The stop loss is one of such tools that is employed in the risk management strategy at any given time. Almost every trader out there uses the stop loss as they eliminate some of the problems emanating from holding live positions in the market.
The Importance of Stop Loss
Stop loss is a vital tool that aids traders remove the need to carry out emotional decisions when trading the market. Market psychology is one that is characterized by fear and greed. There’s are prevalent differences in the way traders express how much they’re willing to lose from a position and the stop loss allows this to be implemented.
When winning trades turn into losing position, traders who have stop loss in place will not experience disastrous losses. In view of the volatility that rocks the forex market, stop loss is a necessary evil to guard against sudden and unpredictable event risk, which usually results in large price moves. Regular stop loss orders are not a guarantee, and can therefore be exposed to the same slippage in fast-moving markets.
Basic Stop Loss Theory
Stop loss are meant to be placed at a reasonable or logical level, i.e. a level that will inform us when our strategy is no longer valid in view of the surrounding market price actions. It is at this point that I’ll love to start with a case study where I will “allow the market cut me out”, meaning that I’ll love to see the market show me that my position is invalid by going to a level that cancels out the setup or alters the near-term market bias.
There’s a second case study where a trader can manually close a trade, although a “set and forget” strategy where the market is allowed to do the dirty work without any interference. One should consider the manual exit before reaching the predetermined stop loss if the market reveals some convincing price action in respect to the position. These case studies are some of the essential logics that professional consider when placing stop loss, rather than depending on emotions.
Let’s consider the case studies that should be considered when placing stop loss on a position:
1) Let your predetermined stop loss be triggered based on market conditions.
2) Exit a position manually due to the formation of price action against your position.
Stop loss levels should be computed at the instance when a trader is getting ready to initiate a position, as it forms a vital part of an investor’s risk and money management strategy. It should be computed based on two essential factors:
- a) How much risk will the equity be exposed to during its session in the market. This should be held at around 2% of the account’s equity.
- b) The second factor is meant to see that stop loss is designed to be relative to the estimated profit. It should be carried out in such a way that the risk of losses on every trade should not greater than the potential profits.