32. How to set a stop loss

Being in a loss in Forex is inevitable. A loss should not bring you down. As a Forex trader you should bear in mind that, the more you can sustain in this market, the more you learn and the more you improve yourself for success. Even though the loss is inevitable if market doesn’t move in your favour, stop loss is a way of cutting down your losses. You might have a clear cut view on how much you can afford to lose. By setting stop losses, you are selecting a point of exiting a trade by which you can cut down your losses and look for new trade opportunities.

article32_1There are many different ways of setting stop losses. We are going to discuss a few of them here:

  • Setting stop losses based on a percentage

One method of setting the stop loss is based on a percentage of the trader’s account. For example a trader feels he can’t afford to lose more than 2% of his account for every trade he does. This is like a hard stop. But, bear in mind it should not be always this 2% which he should risk. He has to look at the market conditions and the trade types to come up with this percentage. A fixed percentage is not always going to work for him. Forex market is very dynamic in nature, so placing a hard stop based on a certain percentage of your account is not a good strategy.  The percentage you would want to risk will depend on the amount of market risk involved.

  • Setting Stop losses based on Support and Resistance

Another way of determining where to place your stop loss is based on the support and resistance lines on your chart. The chart can give you an indication of when the price might break from support and resistance zones and hence placing the stop losses above or below the resistance and support levels can be actually helpful.

  • Setting Stop losses based on Price Volatility

In this method, trader needs to understand the average price volatility in the market. Volatility can be defined as the amount of movement in price in a given period of time. Forex market keeps fluctuating. So if you know the price volatility in the market, you won’t end up placing your stop losses that let you exit very early from the trade. Bollinger Bands are one means of determining the market volatility. Set your stop losses beyond the bands so that price has enough room for fluctuating in the volatility zone before it breaks.

  • Setting Stop losses based on Time Limit

As the heading suggests, this method is about setting stop losses based on time limits. Based on how long you want to keep your trade open, you can decide your stop order. You wait for the price to move in your favour for the time limit you set and you see that the better option would be to close the position and invest the money into a new trade. That is where stop losses based on time limit becomes useful, especially for long-term traders.

Stop losses should be placed carefully and it is not as easy as you think now. Don’t ever let your emotions control your trade. Plan well ahead for each scenario and set your stop losses without panicking.

Trading without stop loss is like driving without wearing a seat belt. Setting stop losses depends on the trading strategy you use. There is no specific rule about setting stop losses. The intention should be to limit your losses when market is not in your favour. Coming up with a strategy to set stop losses as per your needs could take some time, but you should keep trying the same strategy for various trades before moving on to a different one. Keep jotting down stuffs in your journal and you would like to have a look at it later to see how well the strategies worked for you. Good luck and keep trying.