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The use of Stop Losses in Trading

One area that traders need to pay attention to is the use of stop losses. A stop is categorized as a level that is pre-defined, that is set by traders. At this level, the brokers are able to close the trade and allow the trader to automatically exit in the red (at a loss). This prevents the trader from exceeding the maximum amount of loss that they can suffer.

Traders assume that when they enter a trade, they are going to be successful approximately 95% of the time. In actuality, only a mere 30 to 60 percent of the times the trade will be successful or profitable. This expectation will go even lower for some traders. In order to ensure that they manage their losses, traders are required to set stops that will not exceed the maximum amount that they can stand to lose.

When traders use stops, they can accomplish a lot more than what they were doing previously. They are then able to release the tendency that is harbored by so many others, of holding on to a losing position. They tell themselves that if they just hold on to it a little longer, it will become profitable.  One question that is commonly asked by beginners is just where they should set their stops. They wonder if the amount they should allow can be 30, 50, or even 100 pips. This is a difficult question to answer, and a few factors should be taken into consideration to help them to determine their ideal stop level.

  • The first thing they should consider is the currency pair that they plan to trade. Some currency pairs will have a faster movement than others. With the currency pair that moves faster, the allowance is greater than that of a slow moving pair. This allows more room to maneuver their trades.
  • The volatility of the markets is also a major deciding factor in where to put stop losses. Traders who trade for the short term are more prone to using the bigger stops than those who trade for the long term. This requires more funds as there has to be enough to allow for the vicissitudes of the market.
  • Another important factor is the time frame in which they plan to trade in. traders who trade with daily charts are required to place larger stops than those who trade 30 minute or hourly charts. The longer the period, the higher the stop.
  • Traders should choose carefully, the system that they decide to use for trading. Ensure that the defined stops are accurate as systems sometimes malfunction and cause traders to lose on trades that would have otherwise been profitable.

Taking these facts into consideration, the best option would really be to use a stop of 50 pips, but that would not be enough. The stops should be tailored to the trades. If this is not done, there can be negative consequences.

Using stops that are too tight can ultimately put traders at a disadvantage as they end up stopping the trades more often. The use of overly tight stops can cause the trader to miss out on trades that would have turned into a profit. In the same way, too large stop levels can cause a problem with the profitability of the trade. The stop level that is chosen can only be based on the factors that are outlined above. Each trader should use their discretion and figure out where to put the stop on their trade. This can be done by calculating a percentage of the lot they decide to trade.

Allowance should also be made for unwarranted losses. Smaller stops can mean smaller profits, while larger stops can mean larger profits. Remember also that trading should not be attempted by those who feel that they are in unfamiliar territory, as they can end up losing a lot more than they make as soon as they begin. You can earn a lot in a short time, but the reverse is also true, a lot can also be lost in a short time.

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