If you’re relatively new to forex trading, you will have undoubtedly heard numerous terms you’re not all too sure about. Or, the likelihood is, you may know what these terms mean, but not quite know how to execute them. One of which is knowing how to use a stop loss strategy.
From finding the best stop loss strategy to understanding trade management overall, we’ll be covering everything you need in this guide, to help you to create a water-tight stop loss strategy.
What is a stop loss strategy?
Often referred to as ‘stop loss management’, a stop loss strategy involves implementing carefully planned stop loss orders. For example, if you were to buy the Australian dollar/Japanese yen currency pair at a price of 87.20, you would likely place a stop loss order at 87.00 – preventing further losses.
What is take profit?
Take profit, or a ‘take profit order’ is a form of an exit strategy, and should play an important role in your overall stop loss strategy.
While there is no single correct way to take profits – as it can be determined by your forex trading strategy/style and timeframe – one very popular way to take profit in a successful trade is to put an order in to close a position when the next support or resistance level is achieved.
The benefits of executing the best stop loss strategy
Stop loss strategies help to manage your risk while trading forex. Once you have decided what percentage of your account you wish to risk, you can calculate your lot size based on the price point to be used as your stop loss.
During times of high volatility, it’s crucial to protect your account to ensure your capital won’t be lost during these volatile spikes. As forex traders trade at all times of the day, implementing a stop loss strategy can help to preserve your capital and avoid irreparable losses even when you’re not watching your trades.
Here are the benefits of stop loss/take profit overall:
- Stop losses can limit your losses when the trend goes against the trade decision, by automatically exiting the trade at a threshold point. This helps traders to avoid losses after a specific price dip.
- Using a stop loss order is an important tool, removing emotion from decision-making and protecting profit – meaning you won’t need to monitor your trades constantly.
- Taking profits allow you to maximise your profit by exiting a trade as soon as the market is at a favourable price.
Examples of implementing a stop loss strategy
The most commonly known stop loss strategy is known as the ‘Pin Bar Strategy Stop Loss Placement’. This involves putting your stop loss on a pin bar setup that is typically beyond the high or low of the pin bar tail.
Other stop loss strategies include
The inside bar trading strategy stop loss placement
In this stop loss strategy, you’ll place your stop loss on an inside bar setup that is solely beyond the mother bar high or low.
Trade Range Stop Placement
This strategy involves placing your stop loss just over the trading range boundary, or on the high or low of the setup being traded.
Stop loss orders
There are two types of stop loss orders that can be implemented as part of your stop loss strategy.
Buy stop orders: A buy stop order directs a broker to buy an asset once a specific price has been reached, allowing you to take advantage of an uptrend while protecting against losses.
Sell stop orders: A sell stop order instructs a broker to sell a security once it reaches a pre-specified price level. This is typically lower than the market price of the given security and is used to protect accumulated profit from losses.
Setting up your stop loss strategy
It’s crucial that you place your stop loss at a logical level. This means a level that will both inform you when your trade signal is no longer valid, and that actually makes sense in the surrounding market structure.
Knowing how to calculate stop loss and take profit in Forex is incredibly important. But as well as this, it’s imperative to make logical decisions in your stop loss strategy.
Here are our top tips for setting up your stop loss strategy:
- When placing a stop loss, it’s advisable to do it in a way that allows for some market fluctuation.
- If you’re unsure how to set up your stop loss strategy, one comment method is to place them at recent swings. When opening a long position (or a buy position), the stop loss order can be placed below the most recent swing low.
- Using a larger trend analysis will help you form the basis for your stop loss strategy. Setting up static stops can be done with both the following indicators: An average true range indicator and a Fibonacci retracement.
Create the best stop loss strategy with Financial Markets Online
Being a part of Financial Markets Online allows you to gain insight into stop loss, as well as all other areas of forex trading.
As a Financial Markets Online student, you’ll join a dedicated community of active traders who are driven to succeed and implement the right stop loss strategy to their advantage.
If you’re new to forex trading, you can also take a look at our forex beginners guide, where you’ll learn everything from trading terminology to selecting the best trading platforms.