Stop Loss Basics

One of the trickiest concepts in forex trading is management of stop orders. A stop loss order is an order that closes out your trading position with the intent of cutting your losses when the market moves against you.

There is no clear rule of thumb when it comes to placing stops, it all depends on your trading strategy.

If your trading strategy is more of a forex day trading style, you might place a stop just outside of the daily range of the currency pair that you are trading. This way, if the market suddenly breaks the trend that you are trading and moves far enough in the opposite direction, your account is protected because your position is closed.

If your trading style is more of a swing trading style, you might set your stop loss outside of twice to three times the daily range.

Remember, the point of the stop loss is to end the trade when the market goes far enough in the opposite direction, that your trade no longer makes sense. It can be difficult facing the fact that you made the wrong decision, but the markets are as unpredictable as the weather. Sometimes you look at things expecting what seems obvious, only to have the market behave unexpectedly. Setting the stop loss at the time that you enter the trade can help you to draw a “line in the sand” for protection.

No matter what stop loss strategy you choose, remember not to move your stop loss further out to prevent the trade from being stopped out. There are exceptions to every rule, but generally if your stops are getting hit on good trades, you aren’t placing them correctly to begin with. It is better to modify your stop loss strategy. By moving your stop loss to avoid having it hit, you are defeating the protective purpose of it.

When coming up with your stop loss strategy, just remember to set stops that make sense for your account and trading style. The whole point is to limit your losses when you are wrong. If your losses continue to be excessive or your stops are constantly hit, you may need to rethink your system.