Stop losses are an essential tool for all forex traders. Not only do they prevent traders accruing large losses when markets move quickly against a position, but they also allow trading to be more objective and therefore profitable. Sharp and sudden market moves, or simply those trends which occur when a trader is unable to close a trade, can quickly create larger losses and even result in a negative overall account value. Stop losses will go a long way to ensuring that only a certain degree of risk is incurred on any one trade and there are two main ways to utilise this essential tool.
Maximum loss and money stop-losses
Stop losses can be applied to any forex trade on a maximum loss basis, where a trader decides in advance the value of risk that they are willing to apply to a single position. This is known as a money stop and is normally based the maximum percentage loss that a trade can incur. These stop losses are the most helpful in removing the traders emotions form the decision-making during a trade. The temptation to incur greater losses in the hope that a position will recover is something that is experienced by all new traders and the ability to cut these losses early, with the help of a money stop will allow future winning trades to outweigh the losing trades.
Technical stops are used by more experienced traders in order to exit a trade when the chart evidence is that the trade has failed. These stops are therefore placed a strategic points in the market which will prove that the original rationale for the trade is no longer valid and the trading signal has not resulted in the expected outcome. These stop losses are particularly useful for technical traders who use areas of support and resistance alongside technical analysis to pinpoint high probability trading opportunities. Again, by placing a stop loss beyond an area of support or resistance, pivot point or technical chart patter, the trader removers the possibility of a subjective decision dominating their trading decisions. It is worth remembering, however, that technical stops are often placed further from the entry price in order to both allow the trade space to ‘breathe’ and also in order to ensure that the trade setup has failed. The losses with technical stops may therefore be higher than if a money stop were to be employed.
Guaranteed stop losses are offered by many forex brokers as a way to ensure that, even in very fast moving markets or when price spikes occur, a stop loss will be executed at the correct price. This therefore prevents negative slippage when stops are triggered but the losses are higher due to the fact that the price moved beyond this level too fast to complete the stop loss order at the desired price. Guaranteed stop losses, however, do come at a premium which if usually in the form of a wider entry spread which makes the entry price for the trade less attractive as a non-guaranteed stop loss.
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