Definitions
What is Stop Loss Order?
Stop Loss Order is an order designed to limit an investor’s loss by buying (or selling) a financial instrument once its price sails above (or falls below) a certain stop price.
It is an instruction to the trader to exit an existing trade at a price that is worse than the current market.
A buy order is at a rate that is higher then the current market rate, a sell order is at a rate that is lower then the current market rate.
They serve to either protect a trader’s profits or limit your losses.
Stop Loss Order is an Insurance
Stop-loss is the order that limits losses of trader on Forex market and is set to minimize losses during trading.
Correct set of stop-loss is one of the most important conditions for successful trading on Forex market.
Successful traders are unanimous that stop-loss order reduces the risk of loss and increases the chances to get the profit.
However, there are different points of view how to set stop-loss order.
On the one side, if the loss increases stop-loss notices it and closes transaction in order to avoid bigger losses.
On the other side, in the case of rollback, when the price pulls back a few points, touches stop-loss level and then moves in the correct direction this order plays the negative role, stop-loss order prevents the trader to get planned profit.
However, when traders lose deposits they become convinced that the stop-loss order is the reliable insurance against losses on Forex market.
How to setup Stop-loss order?
There are three correct ways to set stop-loss order.
The first way is to fix the lows or highs on the chart. If the trend is upward, the trader starts to buy and analyzes low prices. If the trend is downward the trader starts to sell and analyzes maximum prices.
The second way is based on the use of the price channel lines. For example, if trader opens transaction to buy he sets stop-loss order 10 points below the support level.
If trader opens transaction to sell he sets stop-loss 10 points above the resistance line.
Third way to set stop-loss depends on the currency.
Level of stop-loss is calculated on points:
- GBP = 30-35 points
- EUR = 25-30 points
- CHF = 30-35 points
Setting stop-loss the trader considers the volatility of the currency pair.
Stop-loss is set around 30% of daily currency volatility. For example, if the currency pair CBP/CHF daily volatility is 60 points, the stop-loss order is set at 20 points.
How to set stop-loss when buy transaction is opened?
In this case stop-loss is set below the opening price, in order to stop the losses if the price will fall, not rise.
1. Example of Stop Loss Order
The trader uses currency pair EUR/USD to buy at 1.3225 and sets stop-loss at 1.3215.
Stop loss is 10 points. Spread for this currency pair is 2 points.
To determine the total loss trader sums value of spread and stop loss volume.
In this case, 10 + 2 = 12. If the stop loss works, the loss will be 12 points.
To determine the loss for money trader multiplies the number of points to lot size. If he trades 1 lot, the loss is 12×10 = $120.
How to set stop-loss when sell transaction is opened?
In this case stop-loss is set above the opening price, in order to stop the losses if the price will rise, not fall.
2. Example of Stop Loss Order
The trader uses currency pair EUR/USD to sell at 1.3225 and sets stop-loss at 1.3235. Stop loss is 10 points.
If the stop-loss works, the loss is 12 points, or $120.
Stop-loss order is very important tool when trading on Forex market, it protects deposit from large losses and prevents it from complete damage.
You should never move the stop-loss, it often leads to increase of losses and loss of the deposit.
It will be more correct to re-enter the market than push the stop-loss and take losses.