Defining the Basics: Stop Losses
In my last blog post I mentioned that I’d address stop losses, so here we go!
First of all, a stop loss is placed to reduce potential loss. You can place one wherever you like and if your trade goes badly, it will automatically cease once the loss reaches your chosen point. So, not only do stop losses enable you to limit your losses, they also erase the anxiety caused when you’re losing on an unplanned trade.
Where to place a stop loss is one of the most important considerations before entering a trade, and there are numerous pieces of advice you can find to help you identify where to place one. Here are a few key tips I’ve picked up from my research:
One of the best methods of placing a stop loss is to base it on charts. You can find the places where prices are not pushing or breaking and use this information to place your stop.
Ensure that you set up a time limit to cut off those dead-weight trades. This will allow you some freedom to move on to new opportunities that might work out better for you.
One huge recurring warning I’ve noticed is that you must never base a stop lose only on the amount you’re willing to lose. Basing this decision solely on your account balance is basically akin to begging your trade to lose!
It’s possible to base stop losses on the volatility of a particular pair. If you’re able to identify a rough idea of how much a currency pair moves, this can help you to avoid being prematurely taken out of a trade by price movements.
Obviously, there is still a risk involved here. For example, say you place a stop loss that comes into effect as the trade is not going well - your position is closed and you’ve lost a certain amount of money. There is still a possibility that the market could turn back in your favour, but by that point it will be too late, and you’ll still have made a loss when you might not have had you held your position.
However, stop losses are effectively an insurance policy, and setting them can both prevent huge losses and ease your mind. The flexibility you have with where to place a stop loss also works in your favour, allowing you to have plenty of control over your trades.