For some people, Stop Loss is a taboo and very uncomfortable to be applied. But you need to know that Stop Loss can be useful to protect your trading balance.
I admit that Stop Loss isn't the first thing I learned when I started Forex trading. So, let's be frank; I just noticed how beneficial Forex Stop Loss is after I lost my live accounts. I could have saved it from unnecessary losses had I known how to use Forex Stop Loss earlier. There, please don't wait to be a sore loser like me. Start learning to avoid excessive losses with Forex Stop Loss by reading the guide here!
What is Forex Stop Loss?
As the name suggests, Forex Stop Loss is an automated mechanism to stop out your position(s) when the price goes against your expectation. The leading utility of this feature is to cut current loss before it snowballs into bigger losses automatically. Therefore, a very vital feature for high-risk-high-reward markets like Forex.
Look at the EUR/USD chart above. As you can see, the Stop Loss was set at 1.06500. So, what good will that red line do to your trading position? Say, you entered at 1.05800 and expected the price to decrease to 1.05000. Hence, you opened a short (sell position). However, instead of coming to your estimation, the price keeps increasing.
Forex Stop Loss is an automated safety net to secure your position from volatile market price movements. It'll automatically close your position if the price move against your estimation.
The next thing you know, the price soared to 1.07000, far from your initial prediction. But thanks to Forex Stop Loss, your position was automatically closed at 1.06500. In other words, you have set a security net that has saved you from further -50 pips loss. Well, in the end, it was still a loss. But at least, you incurred less loss than you would if you didn't use Forex Stop Loss.
Why is Forex Stop Loss Important to Learn?
While it's true that the Forex market promises vast returns, it also comes with high risks. If you catch my drift, the profit is only half of the cake. Once, as a beginner, I usually let positions run without Forex Stop Loss. I didn't see the point of using it before, mainly because I was a reasonably successful scalper. I always manually close my position if you didn't get it already. Well, until that time when my friend introduced me to news trading.
Before I Started to Use Forex Stop Loss
Scalping during news trading was, to my experience, akin to riding a jet coaster with a loose security strap. I remembered that it could reap considerable profits in a short amount of time, but that was only half the story. During the news release, price volatility jumped rapidly. You can't expect the price to keep moving in one direction.
Because of that, some of my positions already scored profits, but still, more positions accrued losses after losses. I didn't quite understand what went wrong at that time. The next thing I knew, I suffered the symptoms of overtrading. I kept opening positions during the news release, even though, in the end, I lost more than I could gain. Later, I decided to close my live accounts to stop myself from making worse financial mistakes. Even though I stopped live trading, I was still curious about what worsened my trading performance.
I returned to my friend and consulted about my trading issue there. From there, he identified my trading problem right away. He explained that the main issue was the absence of Forex Stop Loss. Specifically, I closed the profiting position too fast and let the losing position run too long. That's because without Forex Stop Loss I was forced to intervene directly with my active positions. Subsequently, I closed my positions manually based on my fear and anxiety.
So, I tried his advice and started using Forex Stop Loss.
After I Started to Use Forex Stop Loss
At first, I tried to slap all my positions with random Stop Loss values. Well, I didn't see any noticeable improvements, so I kept consulting with my friend. Turned out that I didn't use it the right way. I must also learn about Taking Profit to benefit from Forex Stop Loss optimally. No question asked, I followed his suggestions. A month later, I saw slight improvements in my trading performance. Here's why:
- Forex Stop Loss closed all the losing positions before it turned worse.
- Take Profit "locked-in" all the profiting positions. Especially valuable when a reversal is about to happen, and the price reaches its peak.
- Simply put, Stop Losses reduces the losses while Take Profit secures your gains.
Now, whenever I open a position, I'd set it with preset Forex Stop Loss and Take Profit. Now, I won't let any position run without it anymore.
How to Use Forex Stop Loss?
Each trading terminal comes with a different user interface. Commonly, you need to look at Forex Stop Loss and Take Profit input bars, like this picture below:
MetaTrader4 user interface
Standard Use of Forex Stop Loss
Depending on the current price and your intended entry position, you can adjust Forex Stop Loss by long or short.
Long Position Forex Stop Loss Setup
Use this setup when you are going to buy it. Set Forex Stop Loss value lower than your current ask price ("buy by the market" or higher quote). With this setup, the Stop Loss will trigger when the price drops to your set Stop Loss level.
Short Position Forex Stop Loss Setup
Conversely, Use this short position setup when you are about to sell. Set Forex Stop Loss to value higher than your current bid price ("sell by the market" or lower quote). Therefore, the Stop Loss limit will be triggered when the price moves up to your set Stop Loss level.
Well, that's the most basic setup you can do with the Forex Stop Loss level, but that won't be enough. As I said, you must adjust Stop Loss and Take Profit levels according to the risk vs. reward ratio. In addition, there are also trailing Stop Loss and break-even Stop Loss features. Both are usually preferred over regular Forex Stop Loss when you are swing trading.
Using Trailing Stop Loss or Break Even Stop Loss for Swing Trading
First and foremost, if you're not accustomed to swing trading, leave this section. That's because both are only optimal if your Forex Stop Loss and Take Profit goals are somewhat distanced from your entry. In other words, trailing and break-even Stop Losses will only work effectively if you intend to gain from massive pips movements, like in a range of hundred pips away.
How Trailing Stops works
Let's say you are going to short GBP/USD @ 1.2161. You set Forex Stop Loss @ 1.2300 and Take Profit @ 1.2004. In other words, you set your Stop Loss 140 pips away and Take Profit 158 pips away from your entry price level. That is the defining and clear distinction of swing trading.
Trailing Stop Loss will only work when the position is already in the profit (green zone). So, if you set the trailing stop at 30 pips intervals, it will move 30 pips forward each time the position reaches a certain threshold. Technically speaking, each trading terminal has its definition of what and how this threshold works.
For instance, the cTrader trading terminal comes with its so-called "Advanced Stop Loss" mechanism. In their term, trailing stops will "Trail for" defined intervals each time a designated position makes a "Trigger when gaining" positive pips. So, if you set it to "Trail for" 30 pips and only "Trigger when gaining" 40 pips, the stops will trail 30 pips forward each time the position gains 40 pips into the direction Take Profit limit.
How Break Even Stops work
This mechanism will move your original Forex Stop Loss to your initial entry point. I rarely use this setup because the price is usually reversed and triggers break even Stop Loss before it bounces back up again. Therefore, I recommend you use this setup only when the current trend is strong. But honestly, it's a rare occasion to see any use of this particular setup simply because there weren't many strong trends that could stay moving in one direction for a considerable length.
Precaution for Using Trailing and Break Even Stop Loss
Unpredictable market volatility often renders both of those advanced Stop Losses useless. That's because the price won't stay moving in one direction. Therefore, setting your trailing Stop Loss too tight (read; scalping) will trigger the trailing stop loss too early. Conversely, if it's too far away and you miscalculate the current trend's strength, you won't make any profit either.
Forex Stop Loss is one of the vital tools to protect your running positions from unchecked losses. Before trying a live Forex trading account, you should learn and simulate it on demo accounts.