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AB15 - 3 (Three) Rules To Follow When Using Stop Loss Orders

"There are different ways you can use stop loss orders as we outlined in the previous article. But there are still some basic rules that should be followed. These “best practices” of using stop loss orders will eventually be for your own benefit. Trading is not as simple as buying low and selling high. You need to pay attention to the risks that you are taking when you trade forex. Therefore, managing your stop loss orders is crucial. It can define your overall success and also prevents the trader from taking on undue loss. The better you are at managing the risks, the higher your chances of making a consistent profit in the forex markets. This article will guide you on the three most important things you need to bear in mind when trading with stop losses. These should become second nature so that you automatically follow the rules without having to make a conscious effort."

The word stop loss might bring negative connotations to traders. But the truth of the matter is that stop loss is an integral part of your trading. Whether you are day trading on the 1-hour chart, or swing trading on a daily chart, stop losses are essential.

Many traders struggle with stop loss orders initially. This is of course due to the fact that firstly traders need to get familiar with the charts and the specific behavior of the markets that they are trading. You will often find traders complaining (for the wrong reasons) about how the markets hit their stop loss before reversing direction and going back in the direction of the original position.

This the most common reason when it comes to using stop losses. While it might seem simple in the way the stop loss order is set up, there is quite a bit of difference when it comes to the actual implementation of the stop loss orders.

In this article, we outline some simple tips but important nonetheless that will help you to improve the way on how you set your stop loss orders.

1. Avoid round numbers

Let’s start the very obvious! Never set your stop loss to a round number level. A round number can be a price level such as $1.1100 for the EURUSD, or $1200 in Gold, or $50, $60 and so on in oil.

Round numbers act as price magnets. These are the levels where generally large institutional orders are triggered. In general, a number of traders also tend to set their entry to these levels.

Because a stop loss order is basically a buy or a sell on the counterparty side, price tends to move to these levels quite often. Therefore, if your entry is set to $1.1153, and you want to place your stops near $1.1100, move the stops a bit lower to an odd number.

We should mention that even numbers also act as price magnets. Thus, it is best to avoid these levels. Use obscure price levels such as $1.1327, or $1233 or any other odd number when placing stops.

2. Don’t be rigid in placing your stops

In the previous articles, we mentioned about how stop losses can be set based on the position sizing. While it is important that you do not risk more than 1% of your capital, there has to be some level of flexibility when placing your stop loss orders.

Firstly, don’t open large positions that will make it difficult for you to move your stop loss levels. Rather, stay within the 1% risk threshold but ensure that the stop loss levels is flexible enough.

By flexibility, we basically mean that you should give some breathing space for your trade. This is one of the reasons why many traders complain about their trades being stopped out prematurely. They are too rigid and set the stop loss orders too close to their entry.

A short bout of volatility in the markets can easily strip the stop loss orders move price reverse direction. So, a winning trade actually ends up as a losing trade simply because the stops were too tight.

3. Adjust your stops and aim for break even

Your job is not done after setting the stop loss. After all, when the market moves in your favor, a considerable distance, there is no sense in leaving risk on the table. Therefore, when you have such situations (and you will come across many such situations), always make it a habit to move your stops to the break-even level.

A break-even level is a stop loss level where you do not have any open risk. The break-even price level should also account for the fees such as commissions, spreads, overnight financing. When you move your stops to break-even level, you are essentially not risking any more money. Thus, whatever profits the markets give you, is for you to keep.

The above three rules for stop losses are just the basic but important, nonetheless. As you gain experience in trading forex, you will be able to pick up the nuances of using stop losses. The more familiar you are with the markets that you are trading, the better you will get at managing your stop loss orders.

At the end of the day, your goal as a trader should be to capture profits in the markets without risking too much (or nothing at all in some cases). Thus, using stop losses efficiently can help you to build consistency in your forex trading.

Read 645 times Last modified on Saturday, 15 June 2019 12:08

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