What is a stop loss order?
a stop loss order is an order placed with a forex broker to buy to exit or sell to exit a trade when the currency pair reaches a certain price in order to limit a forex trader’s loss in a trade.
It is is a very important part of the forex money management (or forex trading risk management) process because the stop loss order closes your trade that is running at a loss.
Imagine what would happen if you have no stop loss order?
Your trading losses will increase until you will get a margin call from your broker when your trading account cannot handle the accumulating losses and the forex broker can close down your trade as part of their risk management process.
How do you determine the stop loss position?
You must decide your stop loss placement level before entering the trade because you will be free from emotions then. Don’t make the mistake of figuring out where to place your stop loss after a trade is placed and your trade is running a massive paper loss. That is too late.
Before you take a trade, as part of your trading plan:
- you must determine how much risk you are going to take for the trade.
- Based on that trading risk, you then calculate the price level where you are going to place your stop loss order.
- Take or execute your trade
- Then place stop loss order as soon as the trade is executed.
- When you do this, the stop loss order takes the emotion out of trading decisions
Stop loss positions for a long trade
In forex terminology, long means buy (or a buying). So for a buy trade, you place your stop loss order at a determined price level below your entry price.
So if price falls below your entry price and goes down, your stop loss order will get activated getting you out of a losing trade.
For example, here’s a EURJPY Daily Chart and if you buy at 126.29 and placed a stop loss below the entry price at 125.50, then you would made profit when the price started to move up after you bought:
Stop loss positions for a short trade
Again, in forex terminology, a short trade=a sell trade (so you know).
If you execute a short trade, you want to profit if price moves down below the trade entry price. You don’t want the price to start heading up when you after you take a sell trade!
If the price starts heading up, above your trade entry price, you are going to start suffering a loss, a paper loss. (The only time a paper loss becomes a real trading loss is when you close the trade).
So to protect your trading account and minimize your trading risk, your stop loss must be placed above the sell trade entry price.
Here’s an example of where to place a stop loss order on a sell trade: as you can see, for a sell order, the stop loss order would have been triggered if the price went above 139.59 which means your trade would have been a losing trade:
As you can see from the two charts above:
- for a buy trade, a stop loss order is always placed below the entry price to protect your from further trading loses if price goes down past your entry price to the stop loss order price.
- for a sell trade, a stop loss order is always placed above the entry price to stop further trading loss if price rises above the trade entry price and heads past the stop loss order price.
4 DIFFERENT TYPES OF STOP LOSS ORDERS
Here are 4 main types of stop loss orders and here they are:
- Percentage stop loss order-this is where you first determine what percentage of your forex trading account you are willing to risk on each trade and then place your stop loss order at the price level where you risk will be exactly that if price goes against you.
- Volatility stop loss order-this technique of placing stop loss orders depends on the how many pips a currency pair can move in a given period of time. If for example, GBPUSD moves 100 pips in a day and if you are a swing trader placing a 20 pips stop loss in a GBPUSD TRADE, you will most likely get stopped out too early because your stop loss orders do not account for the fact that this currency pair moves 100 pips in a day on average!
- Chart stop loss order-this is where you place your stop loss orders based on support and resistance levels, pivots, daily high or low etc.
- Time stop loss order-this is where a trader exits a trade with a loss or profit at a predetermined time. This can be a day trader exiting a trade at the end of the day or a trade closing his trade on the last hour on Saturday when the forex market closes to avoid keeping his trade alive during the weekend.
STOP LOSS ORDER EXAMPLES
If you are a new forex trader, you’d be interested to see some examples of stop loss orders,
Note these symbols on the chart below and their meaning:
- TP stands for take profit
- SL stands for Stop Loss
Here’s an example of a stop loss order on an active buy trade:
Here’s an example of a stop loss order on an active sell trade:
Here’s an example of a stop loss order on a pending buy stop order:
Here’s an example of a stop loss order on a pending buy limit order:
Here’s an example of a stop loss order pending sell stop order:
Here’s an example of stop loss order on a pending sell limit order:
ADVANTAGES OF STOP LOSS ORDERS
- Stop loss orders gives you peace of mind meaning that you know if price goes against your trade, you will get stopped out with the amount of money you planned to risk in the first place.
- You don’t have to monitor your trade frequently, you can leave it, go to sleep, go shopping and jump from a plane with a parachute on your back. Your stop loss order will take care of getting your out of a bad trade.
- Removes your emotion from trading because your stop loss order will get you out of a bad trade. Most forex traders make the mistake of letting their trading losses accumulate thinking that the price will turn around and this causes them to delay in getting out from losing trades fast. Therefore having a stop loss order already set in place keeps you away from making this mistake.
- Placing a stop loss order allows you to be confident in your forex trading strategy and it can help you to stay on
DISADVANTAGES OF STOP LOSS ORDERS
Here are the disadvantages of stop loss orders:
- placing your stop loss order is like a cat and mouse game. You never really know if your stop loss order is placed in a price level that can avoid getting stopped out prematurely or not which means there will be times when price will head to your stop loss order, activate it (which means you are out from your trade with a loss) and head in the direction you were hoping it would go in the first place! Like this example below:
- you need to understand the average daily price movement of a currency pair to be able to place stop loss orders that are not going to be stopped out based on the price movement of that currency pair. For example, if you are a position trader and you know that GBPJPY moves 150 pips on average in a day, would placing a 20 pips stop loss make sense? No. That is an example of what I am talking about.
USING STOP LOSS ORDERS TO LOCK IN TRADING PROFITS-HOW?
If you think stop loss orders are just for preventing trading loses, then think again!
You see, stop loss orders are also used for a different purpose too: to increase your trading profits.
Well, as a trailing stop loss. That’s how.
I’ve written a really good post on the best trailing stop technique and you can click that link to read and see how to do that.
So what actually is a trailing stop loss order then?
Well, a trailing stop loss order is simply a stop loss order that is used to lock in profits as price moves in your favor.
This allows you to let your trading profits run and this is one way you can make.
So how does a trailing stop loss work then? Here’s how:
- you place a trade and trade is in profit.
- you move your initial stop loss order to lock in more profits as price starts head in the right direction.
- you continue to move that stop loss order locking in more profits as price continues in the right direction until your take profit target is hit or price reverses and hits your stop loss order.
WHERE IS THE BEST PLACE FOR PLACING A STOP LOSS ORDER?
No trade wants to get stopped out prematurely. The quest for finding the best stop loss placement levels is a quest like searching for the holy grail of forex trading as well.
But having said that, what I have found and continue to find is that there are only two best places for placing a stop loss.
If you want to know more, I have writing a post explaining this, click this like and you’ll be taken there: The Best Places to Place Your Stop Loss Order
WILL USING STOP LOSS ORDERS MAKE YOU A PROFITABLE FOREX TRADER?
This simple answer to this question is this: using stop loss orders in the forex market does not guarantee that you will make money in forex trading.
Forex trading success is a lot more than just placing stop loss orders. It is, however, a necessary part of the risk management process.
Now you understand how to use and trade using a stop loss order. Remember, a stop loss order is about managing your trading risk.
Think of stop loss orders as an insurance policy and it protects your trading account from being wiped in case of price moving against your trading position.