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Investors can make big profits by taking advantage of the high leverage in the Forex market. But just as other highly lucrative markets, Forex is characterized by high volatility and there is a possibility of an investor suffering big losses should things go south. It is for this reason that risk management is a critical aspect of Forex trading.
Investors should employ effective strategies to manage their positions. Stop-loss orders are among the crucial risk management tools every Forex trader needs to know and apply in his day-to-day trading.
What is a Stop-loss?
In Forex trading, a stop loss is a trade order that a trader submits to his broker to sell a currency once its price reaches or goes below a certain level. Stop-loss orders are used to limit losses even when the trader is not actively monitoring the currency movements. Usually, a stop-loss is specified as a number of pips away from the entry price.
Why Stop-loss is Important in Forex trading?
Stop-loss is useful tool for almost all currency trading strategies as it can be attached to both long and short trade positions. No matter how closely one might try to monitor the market, it is impossible to accurately predict Forex market movements. Every day comes with changes that have significant impact on the market, such as global politics, central banks’ actions, and economic events. Many global factors can cause major shifts in the trend of currencies at the snap of a finger. As such, even the savviest trader can find themselves on the adverse side of a market move. When severe market dips happen, stop loss trading can help to close out your position and prevent excessive losses.
Informed Forex traders always include a stop-loss order when placing trades. In fact, you should not, or else you risk blowing your account up with losses when the price trend goes the unexpected way.
Try to get more information from forums or some strategies from other traders that you can use for online stock trading to avoid confusion in the future.
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Four major factors determine the type of stop-loss. These are:
- Percentage
- Price-action
- Volatility
- Time
1. Percentage-based stop-losses
This type of stop-loss considers a percentage of your account size the trader is willing to risk. If you are willing to risk 2.5% of the value of your trading account, you can set a stop-loss equal to 2.5% of the size of the account. An important note here is that you should bear in mind the prevailing market conditions when determining your position. This will to ensure that you only risk 2.5% max (for this example) of the account size. Failure to consider current market conditions can lead you to risking more than the desired value of your account and therefore suffer losses.
2. Price-based stop-losses
This type of stop loss is set based on the price volatility of the currency pair over a certain time period is used to determine price-based stop loss orders. There are various methods of calculating a currency pair’s volatility. Bollinger Bands (measures price volatility) and the ATR indicator (measures a currency pair’s average volatility over time) are among the most commonly used methods.
3. Time-based stop-loss orders
These stop-losses are set based on a pre-specified period. For instance, you can choose to close a trade position at the close of the day, or when the Tokyo-London overlap is over. On Friday, you can decide to close the trades you don’t wish to hold over the weekend .
4. Stop-loss based on levels of support and resistance
These types of stop-losses are more reliable than percentage-based stop-losses. Support and resistance points or levels represent points where the price experiences difficulties breaking through. A stop-loss is placed a number of pip over the resistance level or a number of pips below the level of support. Since there can be fake breaks in the support line, it is smart to leave room for such eventualities when marking a stop-loss.
You cannot always know with certainty how the Forex market will look like tomorrow. Neither can you manage to sit before a computer screen 24/7. Knowing how to set an exit point on a losing trade is probably the most helpful risk management skill in Forex trading. Stop loss trading also eliminates the stress and anxiety of losing trades, which allows you to focus on profitable opportunities that increase your gains.
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