What is stop-loss in forex trading? When it comes to trading forex, everyone wants to keep winning and avoid losing money.
Because if you lose out on a trade, there is no way to recoup your money. And if you make gains on your investments, try to keep them from going back into the market.
But, let’s be honest. The market will always do what it wants and move in the way it wants.
This is why most traders even pro traders use what we call a “stop-loss order” to limit their losses.
In this article, I will be discussing what Stop-Loss In Forex Trading is and how to set up one on your trading account.
What Exactly Is a Stop Loss?
A stop-loss order is a type of order in forex trading to limit losses from trade. It is also referred to as a “stop order” or a “stop-market order”, which results in a set trade being closed at a loss.
A stop-loss order is a request from a trader to their forex broker to execute a trade when the market price is at a specific price level that is lower than the trader’s initial entry price.
No forex trader wants to lose money, but since losing trades is unavoidable in trading, it is better to keep losses small and risk exposure low.
Below is an example of how a stop loss trade looks like on the market chart;
Why Is a Stop Loss So Important in Forex Trading?
Every day presents a new challenge, and almost anything from geopolitics to unexpected economic data releases to central bank policy rumors can shift currency prices one way or the other faster than you can snap your fingers.
This means that we will all eventually take a position on the wrong side of a market move.
Being in a losing position is unavoidable, but we have control over what we do when we find ourselves in that situation.
You can either cut your losses quickly or ride it out in the hope that the market will turn around in your favor.
Of course, that one time it doesn’t go your way could wipe out your account and put an end to your promising trading career in an instant.
Every new forex trader should live by the motto “Live to trade another day!” because the longer you survive, the more you can learn, gain experience, and improve your chances of success.
As a result, the trade management technique of “stop losses” becomes an essential skill and tool in a trader’s toolbox.
Having a predetermined point for exiting a losing trade allows you to cut losses and move on to new opportunities while also removing the anxiety that comes with being in a losing trade without a plan.
Is It A Good Idea To Set A Stop Loss?
Before purchasing a currency pair, the best forex traders will decide where they will sell it if the trade is a loss. They also know that they would buy it back at a loss if they went short on a currency pair.
Using a stop loss is simply an automated way of ensuring that you exit the trade as planned. The same idea as the ‘take profit’ limit orders, which ensure that you exit a winning trade on time.
The main advantage of using a stop loss is knowing that you have an order ready to cut your losses without having to monitor the price movement all day.
This is especially beneficial for part-time traders, which is how most new traders begin. One common argument against setting a stop loss is that they force you to exit a trade too soon.
New traders will recount an experience in which they saw a price drop 2 pips past their stop loss and then reversed back to whether or not they would have taken profits.
This is a frustrating experience, but there are three better alternatives to not using a stop loss.
- Rather than blaming the stop loss, it is possible that where you placed it is the problem.
- Slightly missing out is easily better than incurring a larger loss if the price does not quickly reverse from near your stop price.
- You can close out your position in parts by using an average stop loss method, which means that some of your positions can remain open to take advantage of the trend changes quickly.
How Do You Set a Stop Loss?
One of the most common questions from new traders is how to place a stop-loss order when trading. Risk management and position sizing determine the size of your stop loss.
The steps below will walk you through the process of determining the best stop-loss strategy for any trading system.
- Determine what price would indicate that your trade idea is incorrect—Set the stop loss (SL) order here.
- Set the take profit order (TP) based on what price level the market could move to if you are correct.
- Choose an entry price that ensures that the reward of reaching the TP level outweighs the risk of reaching the SL. A 2:1 risk-to-reward ratio is frequently quoted in trading books.
- The number of pips at stake is the difference between your entry and stop-loss levels.
- Choose a trade size that allows you to risk no more than 2% of your account on the trade. You can place a trade for 5 lots if you can afford to risk $500 and your stop loss is at 50 pips.
It is possible to use a very simple stop-loss system for each trade, such as a 10-pip stop loss. However, this limits the trade’s ability to adjust trading parameters in response to volatility.
What Exactly Is A Guaranteed Stop?
This is a type of stop-loss order in which a trader arranges with their broker, often for a fee, to guarantee that the stop loss will trigger at a predetermined price.
Stop Loss Calculator
Most modern online trading platforms include a stop-loss calculator that traders can use to calculate the stop-loss price or stop-loss value.
However, when researching and learning how to set up a stop loss, a stop loss calculator can be handy. Find a stop loss calculator by searching google
I hope this article has helped you understand exactly what stop-loss in forex trading is, how to set up a stop-loss order, and the importance of using a stop-loss system on your forex account.