Stop Loss and its proper position is the question that I am always asked. Stop loss is a must. You have to set a reasonable stop loss even if you are an intraday trader and you sit at the computer and watch the price movement and all your positions are closed at the end of your trading day.
Stop loss position is very important and you should be able to distinguish where to set it. A too tight stop loss can be easily triggered even when you take the right position. And a too wide stop loss is like having no stop loss.
In addition to showing you the best and most optimum entry point, your trading strategy should be complete enough to show you a proper level for placing the stop loss order whenever it locates a trade setup.
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Where Is the Best Place to Set the Stop Loss?
Stop loss should be placed at the level that gets triggered only when the position you have taken is absolutely wrong.
For example the price is going up. You wait for a reversal signal. The price changes its direction, forms a reversal trade setup, and then starts going down. You take a short position. So the last high that the price has made before it goes down is a resistance level.
Now the question is when you will be realized that taking a short position has been a wrong decision and the price will keep on going up again?
If the price goes up and breaks above the resistance level, it means you were wrong and the uptrend was not reversed. Therefore, you have to be out. That is why professional traders say: You are either right, or you should be out.
So where should you place the stop loss in this example?
Answer: A few pips above the last high (resistance level) plus the spread.
The Importance of the Spread in Short Positions
When you take a short position, you have to add the spread to the value of the level that you consider as the level that stop loss has to be set, because when you take a short position (you sell) you have to buy to close the position and when you buy you have to pay the spread to the broker. You don’t pay the spread when you go short. You pay it when you want to close your short position.
So your stop loss should be a buy order and you have to add the spread to it. This is very important when you trade with the currency pairs that have a high spread. If you don’t do that, your stop loss will be triggered sooner when the price has not actually reached the level you have set the stop loss to.
That is why when you are short and the price goes against you, the stop loss get triggered when the market price is below the level that you have set the stop loss order. When this happens, novice traders think that the broker has hunted the stop loss whereas this is not the case. The gap between the market price and the stop loss level, is the spread that has to be covered before the price reaches the stop loss order level.
But when you take a long position (you buy), you don’t have to add the spread to the stop loss value, because you have already paid it when you bought.
Let me show you some examples.
1. In the below example, you take a short position at 211.74. As I explained above, if the price goes up and breaks the resistance, it means going short was a wrong decision and you have to get out of the market. The resistance level is at 212.39. To set the stop loss, I add 3 to 5 pips to the resistance plus the spread that I consider it 8 pips.
So in this case the stop loss will be 212.39 + 5 pips + 8 pips = 212.52
2. In the below example, you take a long position (you buy) at 214.37. The support level is at 213.56 and the stop loss will be 5 pips under the support level which is 213.61. So here I don’t have to add the spread because it is already paid when entering the market.
So in this case the stop loss will be 213.56 – 5 pips = 213.61
3. Now let’s say you take a long position at 1.4642 after the triangle resistance breakout. As you see in the below chart, the price has broken above a Symmetrical Triangle resistance. The big Bullish candlestick is a good confirmation that the triangle resistance is broken. Therefore, you decide to take a long position when this candlestick is fully formed. But the question is where should you place the stop loss?
A broken resistance should work as a support, and a broken support should work as a resistance. It is always possible that the price turns around to retest a broken support or resistance. While retesting, if price succeeds to break below a broken resistance which was supposed to work as a support, then your long position has to be closed, because it is possible that the price keeps on going down.
In the below example, your long position has to be closed if the price goes down, retests the broken triangle resistance, breaks below it and goes down. To determine the stop loss level, you have to extend the triangle broken resistance and then find a suitable position under the broken resistance. In this case it is 1.4588:
As you see there is no special rule for stop loss like “your stop loss has to be 50 pips under the buy price…”. Stop loss level is different from position to position, even with the same currency pair and time frame. Sometimes your stop loss has to be 50 pips and sometimes 250 pips, depend on the trade setup condition.
When you work with longer time frames, you follow the above stages to determine your stop loss position, but as the longer time frames have larger price movement scales, your stop loss value will be much larger. Therefore, your position size has to be calculated accordingly, not to take too much risk.
Your position size is always calculated based on (1) the stop loss size and (2) the risk percentage, before you enter the market. It means when a trade setup forms and you decide to take a position, first you have to determine the stop loss level, calculate and measure the stop loss pipage, and then calculate the position size based on the the stop loss pipage and risk percentage.
When to Move the Stop Loss
When price moves to your favourite direction and you are making profit, you can move the stop loss further to lock some part of the profit you have made. At least, you can move the stop loss to breakeven (entry price) when you are in a reasonable profit, so that if the market turns around, you will get out with zero loss.
For example, you buy EUR/USD at 1.4642 and your primary stop loss level is 1.4588. The price goes up for 100 pips. You can move your stop loss to 1.4642 which is your entry price (breakeven). Then, if the price keeps on going up for another 100 pips, you can move the stop loss 100 pips higher again.
This is a good strategy to maximize your profit when the price keeps on moving to your desired direction for a long time. But keep in your mind that it doesn’t mean that you have to wait until the price hits your stop loss. To protect your profit, when you see a clear reversal signal, or when the trend looks exhausted, you should close your position immediately and get out before it hits your stop loss.
100 pips was just an example. It is not a rule that has to be followed in all positions. It depends on the conditions and trade setups. For example, when you take a position when a candlestick opens, you have to wait for the candlestick to be formed completely and then decide if you want to move your stop loss or not. You don’t move your stop loss immediately when the price moves accordingly.
Hope the above explanation was clear enough and you learned how to set your stop loss. In case you have any questions, just leave a comment and I will get back to you shortly.
Make sure you NEVER trade without a reasonable stop loss and a proper exit strategy.
Where to Set Limit or Target Orders
Limit order is a good thing to collect your profit before you lose it. It is good to control your greed too. It is better to keep a trade as long as it is moving to the favourite direction and there is no reversal signal, but you can set a limit and collect your profit at a certain level. You should not get upset if the price keeps on following the same direction for several hundreds of pips after hitting your limit. You are already out of the game, but there are always new trade setups on the way, and so you can get in and make profit again.
Determining the limit level can be very easy if you make a rule for yourself. For example you say “I will be happy with 100 pips and want my position to be closed when I have made it”. But it can be hard and complicated if you want to determine the final destination of the price and set your limit accordingly. It is always possible that price doesn’t move according to your expectations, and so it changes its direction before hitting your limit. So you have to be careful.
If you like to earn the maximum profit, you have to determine the final destination of a trend. This can be challenging. First you have to find all the supports and resistances. You have to use the Fibonacci levels and extensions in the best way. When you have a long position, any of the Fibonacci levels can make the price reverse, and so they can be your limit.
The only case that is easy to determine the limit is trading a channel which is when the price is moving inside a channel and goes up and down between a support and resistance line. But even in this case, sometimes the price changes its direction before it hits the limit.
A Better Strategy to Set the Limit Orders
Some traders are used to take a few positions at the same time and with the same stop loss, when a trade setup forms. They set a closer limit order for the first position. When the first position hits the target, they move the stop loss of the other positions to breakeven. When the price keeps on moving accordingly, they move the stop loss further, or close the other positions one by one. This is a good strategy to manage the profit your positions make. But make sure to divide the risk you want to take among the positions. For example, if you want to take a 2% risk with a trade setup, and you want to take 4 positions, then each position has to have a 0.5% risk, and you should not take four 2% risk positions.
How to Manage the Stop Loss in Forex Trading
It is very important to know how to take a position and enter the market. But, it is also very important to know how to manage the position and take your risk as low as possible. You have to learn to make your losses as small as possible. You have to learn to take care of your account balance very carefully and religiously. If you learn to limit your losses, you will win. Big and frequent losses make you disappoint. Therefore, while you learn how and when to enter the market, you should also learn how to manage your position and make your losses as limited as possible.
Fortunately, we can set a stop loss for each position. That helps us make our losses limited. It is not only that. We can move our stop losses, and this is a great feature. We should learn to locate the best place to set a stop loss for each position. I have already explained how to do it, however it is also very important to move the stop loss when it is the time to. It is possible that the market moves toward your favorite direction, but it suddenly turns around and hits your stop loss, before it hits the target. However, if you move the stop loss to breakeven when your position is in profit, it won’t have any risk to hold the position anymore.
We had plotted a resistance line on AUD/USD daily chart and we were waiting for its breakout to go long. Finally, the 2014.06.09 candlestick closed above the resistance line and we took a long position at 0.9349 while the next candlestick was retesting the broken resistance. The stop loss was set at 0.9312 and the target at 0.9715 (about a x10 target) which was the next strong resistance level on the daily and weekly chart. We really expected AUD/USD to go up strongly and test the resistance level and hit our target, first because the breakout was a good looking and valid breakout, and second, because AUD/USD market was already a strong bullish market and everybody was talking about the USD more weakness during the incoming weeks.
However, the AUD/USD market became afraid of a smaller and weaker resistance level on the daily chart at 0.9460 and went down even before it reaches the level. It went down to retest the broken resistance. But, it did not hurt us because we had moved our stop loss to breakeven at the close of the 2014.06.12 candlestick. Although AUD/USD started going up again, but it is not always like that. It could break below the broken resistance and hit our stop loss at its original position:
You could say that it would be OK if we hadn’t moved the stop loss to breakeven, because AUD/USD would go up after retesting and without hitting the stop loss at its original position.
It is true in this case. But it is not going to be like that all the time. If you don’t move your stop loss to breakeven on time, then it is possible that you lose in several consecutive positions. And this will be too hard to recover, both technically and psychologically. It is not only your money that you have to take care of. You have also have to keep your mental situation always in balance. You can easily lose your confidence if you don’t make your losses limited. And if you lose your confidence, you will give up.
When Is It the Best Time to Move the Stop Loss to Breakeven?
I say as soon as possible. If the market moves toward your favourite direction for a few candlesticks (1-3 strong candlesticks with strong bodies), you have to move your stop loss to breakeven, no matter what time frame you are following. If you have a x3 or x4 target, then you’d better to move the stop loss if the market moves for x1 of the stop loss size. You can collect some profit and move the stop loss to breakeven and let your profit run.
Be aware that sometimes your stop loss will be triggered at its original level before the market gives you any chance to move the stop loss to breakeven. You have to be ready for such a situation too. Something that helps you a lot is that you set a reasonable stop loss. A reasonable stop loss is not too wide and too tight. It is reasonable. Your position size should not be too big, so that if the price hits the stop loss, you don’t lose a lot. As a novice trader who wants to start trading with a live account, you should not risk more than 2% of your account for each trade setup.
Before you start trading with your live account, see the below pages/articles/videos:
What If You Don’t Like to Lose at All?
If you don’t like to lose at all, you should not trade forex, because even the best traders lose sometimes. However, as it was explained above, you can make your losses as small and limited as possible. Losing money is part of the game. Get used to it.