This article will provide beginner traders with a clear stop loss strategy definition, a breakdown of stop loss strategies for day trading, and the best stop loss strategies & techniques for forex trading. By reading this article, you will have a better understanding of why you should use stop loss strategies and the various different ways that you can apply stops. You will also find helpful trading tips for stop loss strategies throughout the article.
Why Should You Consider Using Stop Loss Strategies?
Using or 'setting' stops in forex trading is a concept that many beginner traders can mistake for being unimportant, and the importance of using them might be something beginner traders could mistakenly overlook.
Where you choose to place your stops will have a huge impact on your trading performance on various levels. The placement of your stops will ultimately determine your risk-reward ratio, and therefore, the perceived potential success rate of your chosen trading system.
- Risk-reward ratio
- Mimimize loss
- Trading system testing
Stop loss orders are typically placed beneath the market price, so that if the market price performs too negatively in relation to your position, it will minimize the loss that you incur.
Stop losses can of course be amended, but they typically exist as a sort of 'safety net' for professional traders. Stop losses are used to make sure that a trader's risk is minimized as much as possible. By placing a stop loss, you can calculate how much money you are willing to risk for your trade.
Moreover, if your trading strategy needs to be improved or changed significantly, the stop loss placement will also enable you to understand how easily adaptable your trading system is.
Or if this is not the case, then it will indicate to you that you might need to change your trading system. Put simply, stop loss strategies help you to determine how much you are willing to risk, what the potential rewards are, and whether or not your trading system is working for you.
In any case, it is sensible to test your stop loss types (also known as stop loss strategies) before you apply them in the live markets. With MTrading, you can open a free demo trading account on the MetaTrader 4 trading platform, enabling you to test your stop loss strategies on the forex market in a virtual trading environment.
By testing your stop loss strategies with a demo trading account, you can gain access to real-time information, and trade using virtual currency - so that you do not put your capital at risk until you are confident enough that your stop loss strategy will work for you, by which point you can easily and seamlessly transition to a live account. You are in complete control, and make every change and decision when you are ready.
The Best Stop Loss Strategies For Forex Trading
Many beginner traders are often unfamiliar with volatility stops, and as such, this tends to be a stop loss strategy used almost exclusively by professional traders. Volatility stops adapt in response to developing market conditions.
When market volatility is high, professional traders tend to opt to use a larger stop loss in order to prepare for the potential of more dramatic market swings (the market price moving rapidly in a particular direction). By contrast, when market volatility is low, traders tend to use a smaller stop loss, since the chance of the price moving rapidly is smaller, and so too is the risk.
Confluence stops are the most common type of stop loss that professional traders use. With this stop loss strategy, traders make use of a range of tools including trendlines & channels, support & resistance levels, moving averages, Fibonacci retracements, and previous highs & lows (how the market prices performed in the past).
The Confluence area is the point where your indicators all meet. Therefore, the confluence stop loss is placed at this point, or within this area. This strategy can work against traders however, since you are waiting for the price to reach this area, but the price might not reach this area at all within a given trading session.
As the name suggests, this stop is related to the length of time with which you place the stop. With this strategy, traders are encouraged to remove themselves from trades where there are long periods of non-activity or more sideway movements in the markets (as opposed to bearish or bullish movements).
Moreover, this stop loss strategy suggests that it is better to wait for trade signals and then enter those trades, rather than sticking with a specific trade for too long. This strategy also encourages continual movement from trade to trade, at least until you can identify a winning trade.
Therefore, it's more of a 'short-term approach' rather than long-term in terms of waiting and monitoring market activity. Furthermore, the Time-based stop can also be used alongside the volatility and confluence stops, since it is not a 'stand-alone' type of stop loss strategy, and is more of a variable in regards to the placement of the stop loss.
A trailing stop is another example of a stop loss that you can use in combination with another type of stop loss. A trailing stop refers to a type of trade order where the price of the stop loss is not fixed to a particular amount, and is instead fixed to a particular percentage or an amount below the market price.
The trailing stop works by moving in accordance with price increases. Whenever the price increases, the stop is dragged or 'trails' the price. This continues until the price eventually stops rising, and the stop loss sits at its new level (which it was dragged to manually by the trader).
Therefore, this strategy enables the trader to have more flexibility and control over how they react in relation to price movements, as well as potentially increasing their profit potential in real-time, rather than sticking with a fixed stop loss and waiting to see if it will work.
There are many different types of stop loss strategies, and their suitability to you will largely depend on the trading system you are using. It is always important to remember that a stop loss ultimately exists to protect you and minimize your trading risk.
Even the most successful professional traders take the placement of stop losses very seriously, so make sure that you conduct your research carefully, and choose the stop loss that works best for you. Try to focus on improving your trading performance in relation to your trading strategy, and don't just focus on the potential profits you could make in terms of how and where you place your stops.
Make sure to make use of all the trading tools available to you. Try to test out your stop loss strategies continually with a demo trading account, and make sure that you test everything from your trading system to your strategies. By continually reviewing and testing these things, you will ensure that you are employing a system that works, because you are basing your trading on stats, experience, and continual improvement.
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.