Stop-loss will help protect your account from risks that will expose you to major losses. We’re going to explain 4 ways you can use stop-loss orders to pretect your account. Putting a stop-loss order on a trade is easy enough, but how does a trader know when and where to put one?
What is stop-loss?
Stop-loss in trading is an order you request from your broker to reduce the chance of a loss on a trade. This offers you, as the trader, higher financial returns during trading by selling a Security after a certain price is reached for that security.
Before you can understand what a stop loss is, you need to have determined an exit level that you have calculated by using your risk management strategy. Exit strategies typically involve establishing a rationale for exiting a trade and setting prior stop-loss orders to make the exit.
A stop-loss order is a point in the market where your trade will automatically be closed at your pre-determined level / price. It is a “protective order” that closes out a trade at a level when the trade has gone against you.
One key advantage of using a stop–loss order is you do not need to monitor your holdings daily. A disadvantage is that a short-term price fluctuation could activate the stop and trigger an unnecessary closure of the trade.
Where to place stop-loss orders
A stop-loss is placed BELOW your entry point when you are BUYING and ABOVE your entry point when you are SELLING . The simple way to understand the concept of a stop-loss is to think of it as a ‘safety net’. When the market moves against you and the order is running a loss, before the price moves too far away, the stop loss order closes the trade, limiting your downside risk and potentially realising an even bigger loss.
Once the price gets to the level you have placed the stop-loss order at, the trade will automatically be triggered and closed, therefore you will not be in that trade anymore. The definition of a stop-loss is the next available trading level i.e. the next level where the buyers are bidding. Remember there are no guaranteed stop levels. A stop–loss can fail as a loss limitation tool because hitting the stop price triggers a sale but does not guarantee the price at which the sale occurs.
When placing a stop-loss you need to pre-determine and calculate levels so that your risk (monetarily speaking) is correlated with the point you place them at.
How to set a Stop Loss on MT4
ILLUSTRATION Example ON HOW TO PLACE A STOP-LOSS
For following scenario is a buy order
- Determine your entry point and stop loss level
In this example we have determined that we intend to minimise risk and limit our downside by placing a stop loss order at 1827.15 for our long position.
- Click on New Order in the top tab section
3. Place the number referred to in slide 1 in the highlighted box, labelled Stop Loss
4. A dialogue box should appear to confirm that your trade adjustments have been executed
Hover your cursor over the SL line. This allows you to click and drag to modify, as well as see the monetary risk and pip risk.
Then to modify Stop Loss just double click on order and enter the new level.
Stop-Loss and Strategy
There are several approaches available for establishing exit strategies that can help limit the amount of risk traders take on, while increasing the odds for making profits in volatile markets. By using stop loss orders strategically when trading you can decrease your risk appetite.
Financial markets are highly volatile and risky, so forex traders WILL benefit from conducting their due diligence, before participating in exit strategies or other approaches to trading. Losses can exceed deposited funds.
What types of stop-losses are there?
There are four types of stop-losses, namely the percentage stop, the volatility stop, the chart stop, and the time stop. All of these can be ordered within certain windows to prevent losses, or encourage certain outcomes in your favour.
1. The percentage stop
This strategy works by only risking a maximum of 2%. Traders are able to protect their capital put into trading. In the event of a loss, the amount on a 2% risk will not be as detrimental to the trade capital as a higher percentage trade would. There is a drawback to this strategy though. If market conditions are not taken into account it would not allow your trade enough room within the market to gain movement in your favour.
2. The volatility stop
The volatility stop-loss strategy is an interesting type of a stop-loss order. It’s based on past price movements of a particular currency pair. Which means that you can monitor what happened in the past and make decisions about current trades based on those trends.
3. The chart stop
The chart stop makes use of support and resistance levels. By rendering your trade invalidated once the price breaks above either a support or a resistance level. Making sure to exit a trade as soon as possible after it has been invalidated means less risk to you as the trader.
4. The time stop
Placing a time-based stop-loss order is especially useful when a trade isn’t going in any particular direction. It’s also used when you want to exit the market around certain times, like on a Friday evening. Leaving the market during the night takes away the risk that a trade may turn against you. It’s a suitable strategy for traders who prefer to make short-term trades and who exit their positions overnight or over weekends.
Some important things to keep in mind when putting in stop-loss orders
Firstly, avoid trading with very tight stop-loss orders as there is not much room allowed for volatility. Likewise, don’t place a stop-loss order on instruments with a very widespread as high volatility poses the risk of greater loss. Be flexible with the number of pips risked during the trade, but also be sure to place your stop-loss in such a way that your trade will be invalidated in a certain situation.
Finally, avoid placing a stop-loss order directly on a support or resistance line by only trading within a certain zone to ensure you stay away from the line where the price does not count in your favor.
While a stop-loss should not be regarded as a means to treat your trades as a gamble from which you can withdraw when the game isn’t playing out in your favor, it still is a valuable method used by traders that can be greatly beneficial once you get the hang of it.
Check out some of our other blog posts for more tips and tricks of the trade.