Stop Loss Order Explained

What exactly is a “Stop Loss Order”? For complete beginners, it is a very important function on your trading platform that allows you to put an automatic exit on your trade preventing it from incurring any further loss.

Let’s say for example that you opened a LONG order on the forex currency pair of EURUSD at a price of 1.1100 because you have predicted that it will going to rise in the next few days. But if you are wrong, you are willing to risk 30 pips loss so you set your Stop Loss at a price of 1.1070.

Now, assuming that the trend went down against your speculation, your Stop Loss will put a cap of up to 30 pips max loss before closing your trade.

There are actually two ways on how traders utilize Stop Loss.

One: Traders will rely on their Stop Loss in all of their trades to close their positions. It is their main exit plan of getting out from a bad trade.

Two: The second way on how traders use their Stop Loss is when they really needed it. It’s because they exit their trades manually especially when they can see an opportunity that the trend will change in direction. Thus, they may often make necessary adjustments to the positions of their Stop Loss.

Power Outage and Internet Issues

There are some parts of the world where power outage and internet connection are a problematic issues. Just imagine yourself opening up a trade and it was left there hanging on its own when you lost connection. Two things could happen which is either good or bad.

It’s good if you gained profit when your connection came back but you will surely get disappointed when it’s the opposite.

This is the main reason why you should always immediately setup a Stop Loss.

Discipline in Getting out of Bad Trades

The most common mistake by new traders is that, they don’t use Stop Loss because they think that their trading position will reverse back into a winning direction. But this isn’t usually the case, their losing trade will most likely end up incurring bigger amount of loss.

By using Stop Loss on every trade that you make, this actually trains your insight and skill at determining a good exit plan. Thus, you get to discipline yourself about how much risk you are willing to take.

What is a Stop Loss Market Order?

The most commonly used type of Stop Loss is the “Market Order”. All you have to do is to setup the exact Stop Loss price that you want your position to be automatically closed. So when the market price touched it, your trade will immediately be closed.

However, there is one major downside to Stop Loss Market Order which is called, “slippage”. This is a market condition where the prices incur huge fluctuations. If it happens that the sudden movement of the prices went into your losing direction, your Stop Loss may not exactly get triggered at the exact price that you setup.

In short, you end up losing more than the risk that you setup on your Stop Loss position.

Due to slippage, this is the reason why some traders just use Stop Loss only on a worst case scenario. They tend to rely more by manually exiting their trades especially when the trend is on their side.

Anyway, slippage rarely occurs so there is no reason for you to worry so much about it. Using Stop Loss Market Order for exiting your losing trades is still the best protection that you can have.

What is Stop Loss Limit Order?

Another Stop Loss option that you can use is the “Limit Order”. Just like the Market Order above, you get to setup the price that you want your trade to get stopped.

Here’s the good part. You trading position will only be closed by your Stop Loss Limit Order when the current market price gets closely near or exactly at the price that you indicated. It is actually a good way to counter slippage issues.

But here is what you also need to know, Stop Loss Limit Order can turn against you especially during an aggressive market condition. There are chances that your Stop Loss won’t get triggered where it gets bypassed. This could result into a huge loss.

Conclusion

Again, slippage is actually not a main concern because they rarely happen. Thus, it is best to use Stop Loss Market Order as the best exit strategy especially for beginners. As you gain more experience, then you may want to try manual exit but still with a Stop Loss on the side in case the worst unexpected case suddenly occurs.

There is actually no reason for you why you shouldn’t use Stop Loss.

Explaining a Loss - Holding Bad Trades

There were some forex trading strategies that I came across wherein they were enforcing never to use 'stop loss'. In the first place, I also thought that trading without a stop loss can be profitable as the trend always goes back and forth but I was wrong. A trade can never go back that if you haven't placed any stop loss, your position will keep on accumulating more losses that you can never imagine.

Here are the two forex trading strategies that I came across that doesn't require stop loss:

1. Perfect Hedging Strategy

Perfect hedging strategy is an old method where it requires two different brokers. The first broker must be paying high-interest for keeping your position overnight. While the second broker, it does not charge or pay interest. 

What you have to do is to open the currency that pays huge interest on your first broker. This is where your profit will be coming from. On the second method, open the opposite order of the currency that you have opened on your first broker. This will negate your losses.

This method require huge amount of capital and there are only few brokers that features free-interest. Other than that, brokers are now aware of this strategy that when you are caught using it they might close your account.

2. Grid Trading Strategy

Grid trading is a strategy where the method is to setup multiple orders on different levels of prices. As an example you will be setting up pending orders with distant prices of 10, 20, 30 and so on... Since the forex market always moves back and fort - chances are, some of those triggered orders will be in profit. All you have to do is to re-setup all orders that has triggered their target profit.

I already tried this method a couple of times that the bad trades also known as 'dangling' had kept on accumulating into huge losses more than the profit that has been collected.

A Good Trading Plan Always Comes with Stop Loss

If you are still one among those forex traders who does not implement stop loss on their trading strategy then you won't be able to stay in the market for a very long period of time.

Basing your decision on other trader's own speculation is a very bad idea. So as subscribing into those alert signals that tells you exactly when to enter your trades and when to get out. I had to admit that I already had bad experiences with them when I was just starting out as a forex trader. 

One issue was when they kept on telling me that the trend will soon reverse. My position had almost eaten my margin that if the trend still goes in the wrong direction, I will get a 'margin call'.

Just to maintain my position alive, I decided to deposit more money into my broker. As a result, the trend still continued in the opposite direction until it finally cleaned my account. Thus, a good trading plan must always have a stop loss.

Understanding Bad Trades

A bad trade is simply a trade that doesn't work out in your favor. This could mean that you bought a currency pair at a high price, only to see it drop significantly, or that you sold a currency pair at a low price, only to see it increase in value. 

The main problem with bad trades is that traders often hold onto them for too long, hoping that the market will turn in their favor. Unfortunately, this approach often leads to even bigger losses.

One reason traders hold onto bad trades is that they become emotionally attached to them. They might believe that the trade will eventually work out, or that they can't afford to take a loss. However, holding onto a bad trade can be extremely detrimental to your trading account, as it ties up your capital and prevents you from making other, potentially profitable trades.

Common Causes of Bad Trades

There are a number of reasons why traders end up with bad trades. One of the most common causes is overtrading and impulsivity. Traders who are constantly making trades without a clear strategy or plan are more likely to end up with bad trades. This is because they are not taking the time to analyze the market and make informed decisions.

Another common cause of bad trades is a lack of discipline and strategy. Traders who do not have a well-defined trading plan are more likely to make impulsive decisions or to hold onto trades for too long. It's important to have a clear strategy in place before entering the market, so that you can make informed decisions based on your goals and risk tolerance.

Emotional attachment is also a common cause of bad trades. Traders might become emotionally attached to a trade because they have invested a lot of time and effort into analyzing it, or because they have a personal connection to the currency pair. However, emotional attachment can cloud your judgment and prevent you from making rational decisions.

How to Identify a Bad Trade

One of the keys to avoiding bad trades is being able to identify them early on. 

There are a number of signs that a trade might be going bad, including:

- The currency pair is moving against your position

- The market is not behaving as you expected

- Your stop-loss order has been triggered

- You are experiencing a high level of anxiety or stress

When you notice these signs, it's important to take action. One option is to cut your losses and exit the trade. This can be a difficult decision to make, especially if you have invested a lot of time and effort into analyzing the trade. However, cutting your losses early can prevent even bigger losses down the line.

There are also a number of tools and resources that can help you identify bad trades. Technical analysis tools like moving averages and support and resistance levels can help you to identify trends and potential entry and exit points. Fundamental analysis tools like economic calendars and news feeds can help you to stay up-to-date with important events that could impact the market.

Avoiding Bad Trades

The best way to avoid bad trades is to have a well-defined trading plan in place. This plan should include clear entry and exit points, as well as risk management strategies like stop-loss orders and position sizing. By having a plan in place, you can make informed decisions based on your goals and risk tolerance, rather than reacting impulsively to market movements.

Risk management is also a key component of avoiding bad trades. This means setting a maximum amount of capital that you are willing to risk on each trade, and sticking to this limit. It's also important to use stop-loss orders to limit your potential losses if the market moves against you.

In addition to having a plan and managing risk, it's important to develop discipline in your trading. This means being patient and waiting for the right opportunities, rather than constantly making trades just to be active in the market. It also means being able to cut your losses when necessary, rather than holding onto a bad trade in the hopes that it will turn around.

Dealing with Bad Trades

Despite your best efforts, it's possible that you will end up with a bad trade at some point. When this happens, it's important to take action to minimize your losses and turn the experience into a learning opportunity.

One strategy for managing a bad trade is to scale out of your position. This means gradually reducing the size of your position as the market moves against you. This can help to limit your potential losses and preserve your capital for future trades.

Another strategy is to use a trailing stop-loss order. This is an order that is placed a certain distance away from the current market price, and that moves up or down as the market moves in your favor or against you. This can help to limit your potential losses while still allowing you to take advantage of any potential gains.

Finally, it's important to view bad trades as learning opportunities. Take the time to analyze what went wrong with the trade, and use this information to improve your trading strategy going forward. This might mean adjusting your risk management strategies, re-evaluating your analysis methods, or simply learning to be more disciplined in your trading.

Conclusion

Holding onto bad trades can be a costly mistake for Forex traders. It's important to understand the potential risks and consequences of holding onto a bad trade, and to develop strategies for avoiding and managing these situations. 

By having a well-defined trading plan, managing risk, and developing discipline in your trading, you can minimize your losses and increase your chances of success in the Forex market. Remember that bad trades can also be valuable learning opportunities, and use these experiences to improve your trading strategy going forward.

The Importance of Using a Stop Loss

Predicting the direction of the forex market with one-hundred percent accuracy is impossible. Even professional traders claims that there is no perfect strategy that will always provide guaranteed results. 

Strategies that provide around sixty percent of accuracy and above are already profitable. 

Let’s consider for an example that you have a trading method with 70 percent of accuracy then that leaves you the remaining 30 percent the risk or danger of losing some of your investment. 

If you don’t have a proper money management method then you can lose a lot of money.

To prevent further loses, every forex broker platform have the function that allows you to place a stop loss. 

If your broker’s trading platform doesn’t have the option for you to setup your stop loss level then its time to look for a better broker. 

There are several forex brokers out there that you can easily join and they even provide some promising promotional bonuses upon registration but the most important part is their trading platform. 

Before creating an account, it is highly suggested that you should try their demo or virtual account for testing purposes. If you think that you are completely satisfied then go ahead and register for an account.

The most popular trading platform is the Meta trader 4 or more commonly known as the MT4. 

It contains almost all of the basic indicator tools by default and you can customize them they way you want it to be. 

One of the best parts on using an MT4 is the Expert Advisor function. This option allows you to run a programmed script that can perform automated trading for you.

Modifying Stop Loss

Moreover, forex is not a simple game where your emotions also do play an important role. 

It can affect your trades by deciding to adjust your current trade’s Take-Profit or Stop Loss thinking that you can earn more or the trend will reverse back on the opposite direction. 

This action can result into a huge loss leading into an early retirement on your forex trading career. If you have a good strategy then always stick with its rules.

Importance of Risk Management

Before diving into the importance of using a stop loss order, it is crucial to understand the importance of risk management in forex trading. 

Forex trading involves a high degree of risk due to the volatility of currency exchange rates. 

It is therefore important for traders to implement risk management techniques in order to minimize potential losses and preserve capital. 

Risk management techniques can include the use of stop loss orders, position sizing, diversification, and more.

Purpose of Stop Loss Orders

A stop loss order is a risk management tool used by traders to limit their potential losses. 

A stop loss order is an instruction to the broker to automatically sell or buy a currency pair once it reaches a specific price point, known as the stop loss level. 

The stop loss level is set by the trader and is typically based on a percentage of their trading account balance or based on technical analysis of the market.

What is a Stop Loss Order

A. Definition of a Stop Loss

A stop loss is an order placed with a broker to automatically sell or buy a currency pair once it reaches a specified price level. 

The purpose of a stop loss is to limit potential losses by closing out a position once it reaches a predetermined level.

B. How Stop Loss Works in Forex Trading

In forex trading, a stop loss order is typically placed with a broker when a trader enters a new position. The stop loss order is attached to the position and remains active until the position is closed out. 

If the market moves against the trader and the price reaches the stop loss level, the stop loss order is triggered and the position is closed out automatically.

C. Types of Stop Loss Orders

There are several types of stop loss orders that traders can use, including fixed stop loss, trailing stop loss, and guaranteed stop loss.

1. Fixed Stop Loss

A fixed stop loss is the most common type of stop loss order used in forex trading. It is a predetermined price level set by the trader when entering a position. 

Once the market reaches the predetermined price level, the stop loss order is triggered and the position is closed out.

2. Trailing Stop Loss

A trailing stop loss is a type of stop loss order that is based on the price movement of the currency pair. 

It is used to protect profits by automatically adjusting the stop loss level as the price of the currency pair moves in favor of the trader. 

If the market moves against the trader, the stop loss level remains fixed and the position is closed out once the stop loss level is reached.

3. Guaranteed Stop Loss

A guaranteed stop loss is a type of stop loss order that is guaranteed to be executed at the specified price level, regardless of market volatility or liquidity. 

It is a premium service offered by some brokers and is typically more expensive than a regular stop loss order.

Advantages of Using a Stop Loss Order

A. Helps to Limit Potential Losses

The main advantage of using a stop loss order is that it helps to limit potential losses. 

By setting a predetermined stop loss level, traders can control the amount of risk they are willing to take on each trade. 

This can help to prevent large losses that could have a significant impact on their trading account balance.

B. Allows Traders to Set Predefined Risk Levels

Another advantage of using a stop loss order is that it allows traders to set predefined risk levels. 

This means that traders can set a specific percentage of their trading account balance as the maximum amount they are willing to risk on each trade. 

This can help to ensure that traders do not take on too much risk and blow their trading account.

C. Provides Peace of Mind and Reduces Emotional Trading

Using a stop loss order can also provide traders with peace of mind and reduce emotional trading. 

By setting a predetermined stop loss level, traders can feel more confident and less emotional about their trades. 

They can also avoid the temptation to hold onto losing trades in the hope that the market will turn around, which can lead to even bigger losses.

Disadvantages of Not Using a Stop Loss Order

A. Risk of Significant Losses

One of the main disadvantages of not using a stop loss order is the risk of significant losses. 

Without a stop loss order, traders may hold onto losing positions for too long, hoping that the market will turn around. This can lead to even bigger losses if the market continues to move against them.

B. Lack of Control Over Potential Losses

Another disadvantage of not using a stop loss order is the lack of control over potential losses. Without a stop loss order, traders may not have a plan in place for limiting their losses. 

This can lead to emotional decision-making and impulsive trading, which can result in significant losses.

C. Emotional Trading and Decision Making

Not using a stop loss order can also lead to emotional trading and decision making. Without a stop loss order, traders may hold onto losing positions for too long, hoping that the market will turn around. 

This can lead to emotional decision-making and impulsive trading, which can result in significant losses.

Importance of Using a Stop Loss in Forex Trading

A. Limits Risk Exposure

The most important reason for using a stop loss order in forex trading is to limit risk exposure. 

By setting a predetermined stop loss level, traders can control the amount of risk they are willing to take on each trade. 

This can help to prevent large losses that could have a significant impact on their trading account balance.

B. Helps Traders Stay Disciplined

Using a stop loss order can also help traders stay disciplined. By setting a predetermined stop loss level, traders can avoid emotional decision-making and impulsive trading. 

This can help to ensure that traders stick to their trading plan and avoid making costly mistakes.

C. Improves Trading Strategies

Finally, using a stop loss order can help traders improve their trading strategies. By analyzing their trades and adjusting their stop loss levels, traders can identify trends and patterns in the market. 

This can help them to make more informed trading decisions and improve their overall trading performance.

Tips for Setting Effective Stop Loss Orders

A. Determining Risk Tolerance

Before setting a stop loss order, traders should determine their risk tolerance. This will help them to determine the appropriate stop loss level for each trade. 

Traders should consider their trading account balance, their trading goals, and their overall risk tolerance when setting their stop loss levels.

B. Identifying Key Support and Resistance Levels

Traders should also identify key support and resistance levels when setting their stop loss levels. 

Support and resistance levels are areas on the chart where the price of the currency pair is likely to bounce or reverse. 

By setting their stop loss levels just below key support or resistance levels, traders can help to ensure that their positions are closed out before the market turns against them.

C. Utilizing Technical Analysis

Finally, traders should utilize technical analysis when setting their stop loss levels. Technical analysis involves analyzing charts and indicators to identify trends and patterns in the market. 

By using technical analysis, traders can identify key levels of support and resistance, as well as potential entry and exit points. 

This can help traders to set more effective stop loss levels and make more informed trading decisions.

Final Words

In conclusion, using a stop loss order is a critical aspect of forex trading. It allows traders to limit their risk exposure, set predefined risk levels, and stay disciplined in their trading. 

Not using a stop loss order can lead to significant losses, emotional decision-making, and impulsive trading. 

By setting effective stop loss levels, traders can improve their overall trading performance and increase their chances of success in the forex market.