Why Trading with a Stop Loss is Essential

Stop Loss – If there’s one thing every forex trader needs to know, it’s that trading with a SL in place is absolutely essential.

A stop loss is the amount at which a trade that is losing profit will automatically close at. It protects a trader from losing control of their account in the event that a trade runs away from them — and, combined with a take profit, it creates far more consistent performance and results for the trader.

Try reading: Identifying the Best Times to Trade Forex

KEY: SL = Stop-Loss

Here is all the information that you need about how a SL works and why it’s essential…

How Does a SL Work?

A stop loss is exactly what it sounds like: it stops a trade after the trade has experienced a certain amount of loss.

A trader can initiate a trade with a SL set up, which will indicate the price at which the trade should automatically close and take any losses. You can also update any current or pending trades to add a stop loss.

A SL is often incorporated into different trading strategies; it may be set at a certain support or resistance point, at a certain amount of pips away from the current trading price, or at a percentage of volatility. All of these are viable as long as they remain a consistent part of the trading strategy.

A SL can be seen as the opposite of a take profit, which takes the trade’s profit once it reaches a certain price. Together, a stop loss and a take profit set the outer boundaries of a trade; a trader knows with a stop loss and take profit that the forex order is either going to close low at the set stop loss price, or the set take profit high price. There are no other alternatives. This creates consistency and stability; each time a trader embarks upon a new trade, they know they are either going to lose a specific amount or gain a specific amount.

 

Naturally forex traders will usually set a take profit higher than a SL , but this isn’t always true; traders with a lot of confidence in their trading techniques may actually set their take profits quite low (so they take profit more often) and their stop losses fairly wide (as a last resort).

The Different Types of Stop Loss

There are two types of stop-losses: a fixed SL and a trailing SL.

The Fixed Stop Loss

A fixed SL is simply a price at which the trade is going to close regardless of the situation.

A fixed stop loss can be set at any amount away from the current market price. For more stable currencies, it can be very close; for more volatile currencies, it is better to position it farther away, as the currency could fluctuate for small intervals. But the major problem that many traders have with a fixed stop loss is that it can either become entirely superfluous (as the trade moves upwards) or it can be triggered too soon (as the trade naturally fluctuates).

For this reason, many forex traders prefer to use a trailing stop loss instead.

The Trailing Stop Loss

A trailing SL “follows” the current market price at a certain distance, such as 20 pips.

Once a trade is profitable enough, it cannot lose money any longer; it will always close once the order has lost enough money to fall that specified interval. So if a trade has gained 200 pips and it has a stop loss of 20 pips, a trader is now guaranteed a profit of at least 180 pips. Comparatively, a trader could have had a similar trade with a fixed stop loss at -20 pips off the original market price. With the fixed SL, it would still be possible for the trader to lose 20 pips rather than gain anything, if the trade suddenly went south.

Trailing stop losses are preferred by a large number of traders, but beware as they are an advanced trading technique. The challenge of a trailing stop loss is that it can be triggered too early if it is set too close. Many currency pairs go up and down at staggered rates, so a trailing SL has to be set outside of the range of normal volatility.

Some traders feel that a trailing stop loss should be completely replaced by only a take profit for that reason.

The Importance of Trading with a Stop Loss

Trades can go south very quickly.

Trading with a SL is important for two critical reasons: it helps you avoid large losses, and it makes sure that your trades remain consistent.

When you initiate a forex order, you should already know exactly when you want to take your profit or accept a loss. Only an emotional trader will change these amounts mid-trade — barring any unusual events, such as a sudden market shift or a global economic event. It’s important to remain consistent when you’re trading, and a stop loss makes this consistency automatic.

But a stop loss is also important because currencies can lose their value very quickly. A single market event could see a sudden shift in the wrong direction for a trade. It makes sure that there’s an absolute limit on the amount that you can lose. You know that you cannot possibly lose more money than your stop loss suggests.

Not only does this help you with your cash and account management, but it also helps you tilt your trades in your favor — especially when you’re working with currency that is experiencing fluctuations in either direction.

Trading Without a Stop Loss

There are forex traders who believe that particularly volatile currency pairs will hit the stop loss too often; the currency may spike downwards suddenly but recover within seconds.

While this is true, this doesn’t mean that a stop loss shouldn’t be used. Instead, it means that it should be set at a wider margin. A currency spike downwards can still lead to margin calls and other account issues, and thus it needs to be protected against. There is a certain amount of loss that simply shouldn’t be tolerated on a per trade basis even if the currency pair is particularly volatile. So, the answer is simple: no. You can trade with a wider stop loss, but it is highly recommended to always have a stop loss in place.

A stop loss is one of the basic building blocks for a beginning trader. By learning how to appropriately set up this key trading function, you will be learning simultaneously how to manage your risk.

Many trading signal providers – like us here at FxPremiere, will tell you exactly where you should place your stop loss depending on the current market volatility and outlook.

Stop losses can be an invaluable tool for maximizing profits and they should never be forgotten!

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