What is Stop Loss?admin 20 September 2021
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Estimating profits and reducing potential losses is very important for those who trade in financial markets. However, these traders often set “take-profit” and “stop-loss” levels for their trading positions. If you use trading platforms such as MetaTrader to do forex trading, you must have worked with the Stop loss option. By choosing this option, you will significantly reduce the losses that may occur due to future market fluctuations. Therefore, it is best to use this tool to better control and reduce the negative effects of your transactions.
To limit their trading risk, traders need to plan and specify the exit point of the trade. In this regard, the stop loss order may be considered a compensatory order that closes your trades after reaching a certain level.
Imagine you have activated the sell position for the GBP/USD pair at the price of $1.3819, and you predict that it will decrease to the level of $1.3720. So, you register the “take profit” at this level. But if your prediction is wrong and the market moves in the opposite direction, you set a stop loss at $1.3840 to avoid losses. This stop loss will be activated at the level of $1.3840, thus preventing further loss. Keep in mind that this order will not be executed if the price never reaches the $1.3840 level.
How to determine a stop-loss strategy
You should never determine Stop loss randomly. Determining it is a strategic choice that should be based on practice and experiments. When you have enough information before entering the market, you will find out which strategy is more suitable for you, considering the amount of your capital.
Also, you must set up a plan based on how you want to enter trades, control risk, and exit trades after you make a profit. It is crucial to pay attention to the process of daily trading and control the risk. It is best to use simple ways to trade at first. Make your trades based on the general market trend. In this case, if the market moves against your predictions, you can reduce your loss by setting a stop-loss.
Stop-loss determination methods
In general, a stop loss can be divided into two types of fixed and trailing. However, other types help you calculate the stop-loss according to the percentage of capital, using support and resistance levels and the moving average.
As we mentioned before, to reduce the trading risk and based on the type of trading position (buy or sell), you specify a level as a stop-loss. When the market reaches this level, your buy or sell order will stop, and it prevents your further loss.
Trailing stop loss
A trailing stop-loss is a type of daily trading order that allows you to determine the maximum amount of a loss in a trade. If the price of the asset increases or decreases in your favour, the stop-loss will move with it accordingly. However, if the increase or decrease in the price of an asset is not in your favour, the stop-loss will remain the same.
Imagine you decide to buy WTI oil at $66.57. You have also set your stop loss at $66.40. If the oil price goes higher to $66.67, your stop-loss will change to $66.50. Also, if the price reaches $66.50 in a downtrend, the stop-loss will be activated for you, and your position will be closed.
Determining stop-loss based on the capital percentage
This method is set based on a predetermined percentage of the trading account. For example, you are willing to expose your total capital to a 5% risk. However, it may help if you remember that this rate can also change based on different percentages of risk-taking in individuals. The trader then determines the stop-loss based on the desired entry point.
Using support and resistance levels
Usually, price movements in a chart cannot exceed certain levels. In most cases, when the market trend reaches support and resistance levels, these levels do not allow further progress. But since these areas are not accurate, make sure you consider market fluctuations when specifying stop loss in this way.
Using the moving average
The use of moving average in determining the stop-loss seems appropriate for those who use trailing strategies. As already mentioned, this type of technical analysis identifies support and resistance levels for you. However, suppose you want to use a moving average to determine stop-loss. In that case, it is better to use averages with periods of 20,50,100, which are very popular among traders.
As we stated many times, the first step in investing in financial markets, especially Forex, is education and gaining information. This will help you find the right strategy and trade accordingly. The next step that saves you from facing many losses is to determine the stop-loss in trades. To determine it, you must also pay attention to several factors such as trading volume and price. Also, avoid setting a random stop-loss or not setting one at all, which usually happens for fear of losing trading positions.