What is Stop Loss Order in Forex trading?
Apart from Take Profit, an equally important pre-calculated price level used by traders today is called Stop Loss. As the name suggests, this is a type of pending order that allows the trader to set a predefined level on the price chart that closes a losing position. In other words, it ensures a minimum loss as it closes the position. Stop Loss is abbreviated as (S/L). For example, a trader goes long (in other words, enters a buy position) by entering the market at 1.2980, expecting prices to rally higher. He knows that the market is unpredictable, however, and that it may go in the opposite direction than his expectation. So he calculates the risk before entering the market, and places a Stop Loss order below the entry price. If the Bid price hits the predefined Stop Loss price at 1.2880, the position is closed and a minimum loss is ensured.
Similarly, if a trader enters a sell (short) position, expecting prices to fall, he would place a protective Stop Loss order at a higher level than the entry price in case prices spike up. If the Ask price hits the predefined Stop Loss price, the position is closed and minimum loss is ensured.
Stop Loss has been designed to protect your capital by ensuring a minimum loss; it is a level set by the trader in advance according to how much he or she is willing to risk and/or lose. It’s important to remember that Stop Loss and/or Take Profit orders may be placed on Instant Execution accounts simultaneously when entering the market. On Market Execution accounts, you can specify a Stop Loss or Take Profit order when placing a pending order to enter the market.
Stop Loss and Take Profit are both crucial elements of Risk Management – something that will be covered in a future video.
Why use a Stop Loss Order?
The forex market can be very volatile and small losses can quickly accumulate. Protecting your capital with limit orders is crucial, especially when trading with leverage, which can amplify any losses.
Setting a Stop Loss (S/L) will:
- Allow you to step away: you can take a break from trading knowing there’s a cap on potential losses.
- Take the emotion out of the trade: you’ll be protected against the urge to hold the position for too long, or to close it too soon.
- Mitigate risk: exiting the trade when your limit is reached can prevent large losses if the market makes a big move against you.
Where should I set my Stop Loss?
Most traders aim to make a loss of no more than 2% of their total capital on any single trade. Based on this, let’s calculate the distance between the opening price and the Stop Loss in a typical forex trade.Example Stop-Loss calculation:
- You have capital of $10,000 dollars
- You open a EURUSD position with a volume of 1 lot (1 lot = 100,000 EUR)
- One point of price movement is worth $10
- 2% of your capital is $200. Divide this by the value of one point’s price movement:
- 200/10 = 20
- So, the Stop Loss limit order should be placed 20 points away from the opening price of the transaction.
Please be aware:
You cannot completely avoid trading losses with Stop Loss orders. They are just one method to potentially plan for potential losses. Remember, you can also use Sell Limits or Stop Limits.
Can I change a Stop Loss Order while my position is open?
You can adjust or cancel a Stop Loss order while your trade is open and you’re monitoring the market. You can also add a Stop Loss to a position that’s already open.
Three good rules for setting up Stop Losses in forex:
- Don’t let emotions be the reason you move a Stop Loss. Any adjustments should be pre-determined before you place your trade.
- Trail your stop. This means letting it move in the direction of a winning trade using a ‘Trailing Stop’. It locks in profits and helps you to manage the risk if you add to your open position.
- Never widen your stop. This is like not having a stop at all – it’ll only increase your risk and the amount you could lose.