All profit opportunities in global markets carry a certain amount of
risk, and the Forex market is no different in this regard.To get more
news about
Trading Strategy , you can visit wikifx.com official website.
While there are many ways to keep risks under control and limit risks,
one of the most effective and most widely used are stop-loss orders.
Stop-losses play an integral part in any well-round risk management and
should be well understood, even before you place your first trade in
your trading career.
Underestimating risks and accumulating losses are arguably the number
one mistake that new traders make in the markets. Here, were going to
explain how to keep an eye on your risks and limit losses when
everything turns against you using a simple tool – stop-loss orders.
What is a Stop-loss and Why Should You Care？
There is a saying in the trading community that 90% of traders lose
90% of their trading capital within 90 days. While successful trading
depends on a variety of factors, this statistic could have been much
better if new traders used stop-loss orders in an effective way, as part
of a well-designed trading plan.
So what is a stop-loss exactly？ A stop-loss is a pending order that
automatically exits a trade when the market turns against the position,
that is, it sells a long position or buys back a short position. In
essence, a stop-loss order becomes a market order once the market
reaches a pre-specified price-level, also called the stop-loss level.
This helps traders to avoid unexpected losses in the event of
increased volatility or during times when the trader is not in front of
his trading platform. Additionally, a stop-loss order combined with a
take-profit order can eliminate any further work regarding a trade by
simply letting the position to perform.
How do Stop-Loss Orders Work？
In essence, stop-loss orders are buy stop and sell stop orders that
get executed when the market reaches a pre-specified level. If youre
long, stop-losses sell your position, and vice-versa.
It‘s important to note that a stop-loss order always follows the ask
rate when applied to a short position, and the bid rate when applied to a
long position. For example, if you’re long EUR/USD at 1.1050/52 and
place a stop-loss order at 1.1020, the stop-loss will get triggered only
if the bid rate reaches that level.
During times of high market volatility, such as when important market
reports get released, imbalances in the market may lead to slippage and
the widening of spreads, which in turn might fill your stop-loss order
at a significantly different price. In fact, almost 44% of all stop and
stop entry orders received negative slippage, according to the slippage
statistics of a large broker.
Reward-to-Risk Ratios
Preferably, a stop-loss order should be placed tighter than the
potential profit target in order to maximize a trades risk-to-reward
ratio and improve profitability in the long run. By taking R/R ratios
into consideration, even a mediocre win rate of 50% can return
significant profits as the average profits of a winning position will be
higher than the average losses of losing positions.
Types of Stop-Loss Orders: Pros and Cons
Depending on the technique traders use to find potential stop-loss
levels for a trade, stop-loss orders can be divided into four main
types: chart stops, volatility stops, time stops, and percentage stops.
Another popular type of stop-losses that has seen the day of light just
recently is the guaranteed stop, which will be discussed further below.
Chart Stops
Chart stops are arguably the most effective and popular stop-loss
type. Theyre based on important technical levels, such as support and
resistance level, trendline, channels, moving averages, or chart
patterns, to name a few. The stop is then placed just below/above that
level with the expectation that if it gets broken, the current momentum
has shifted and the trade idea has been invalidated.
In general, a chart stop should be placed by looking at what the chart
is showing us to be important technical levels and not by how much a
trader can afford to lose. Therefore, a stop-loss order should be placed
around an area where youre not interested to stay in the trade if
breached, allowing for an easy and fast exit out of the market.
Keep in mind that in times of high market volatility, wider
stop-losses should be used to account for sudden price fluctuations.
Giving a trade space to breathe avoids that you get stopped out by
market noise – If youre a shorter-term trader, placing a stop-loss with a
20 pips leeway provides you with enough room to withstand sudden
price-spikes and regular fluctuations.
The Wall