Trading without a stop loss is like diving into the deep end without knowing how to swim. Just like you could drown in the waters of your community pool, you could drown in the proverbial waves of the market. When it comes to trading, your stop loss is your life jacket and you don’t want to enter the market without one. Stop losses help traders decide the appropriate time to exit a position and deciding when to exit is just as important as determining when to enter.
Stop Loss 101
Simply stated, a stop loss is designed to limit a trader’s loss on a security position. For example, setting a stop loss order for 10% below the price at which you bought the stock, option, or currency pair will limit your loss to 10%. Let’s say you just purchased GBP/USD at 1.5100. Right after buying the currency, you enter a stop loss order at 1.5050. This means that if the currency pair falls below 1.5050, your trade will then be closed at the prevailing market price, resulting in a loss of just 50 pips.
Why set one up?
Stop losses help strategize your losses without letting emotions get the best of you. There are multiple strategies for setting up stop losses, but really it comes down to personal preference and comfortability. Just like we encourage our students to create and implement their own trading constitutions, we encourage you to find and enforce your own stop loss strategy based on your risk tolerance.
Don’t worry, we won’t let you wade the waters without a little guidance. Here are three of the most popular stop loss techniques traders tend to favor.
This type of stop loss is meant to protect your capital. Even pro traders find that they don’t always make winning trades. Don’t let this scare you; losses are expected when trading. As long as the overall dollars gained outnumber the dollars you’ve lost, you could still be profitable in the market.
This stop loss is more fluid than initial stops and is designed to protect your profit. Once a trade begins to trend in the direction of your favor, you could follow the trend by moving your stop. You could also decide to collect if the trade hits your profit target. Once you learn how to protect your profits as well as your initial capital, you could be well on your way to trading like an expert.
This stop loss is pretty self-explanatory. Break-even stops could help lock in a no-loss trade. They are best suited once a trade has gone in your direction and there is little threat of the initial stop being hit. Once you apply a little bit of leverage and move your stop to be breakeven stop loss, you could end up with a profitable trade. Our experts have discovered by firsthand experience, that this strategy could be ideal if you move your stops as soon as reasonably possible. This could help you minimize the potential drawdown of your account.
The simple truth is that without a clear understanding of stop losses, you could be sacrificing your financial future. A stop loss tells you when to climb out of the deep end and get out of your trade. Do you utilize stop losses in your trades? Tell us how in the comments below.
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