Stop Loss Strategies For The “DUMB” Trader - Forex Anatomy

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Stop Loss Strategies For The “DUMB” Trader

One of the most challenging procedures to master as a currency trader is in determining the placement of a stop loss order during a trade. The topic of stop loss placement has been the subject of much heated debate among forex traders for decades, because there is no definite “right or wrong” plan on where traders should place their stop loss orders. In all honesty, it solely depends on a trader’s preferred style of risk management and their overall trading method.  Yet, despite this fact, there are still a few pointers that must be considered when applying stop loss strategies in the forex market.

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Before, I share with you some of these factors and stop loss tips, I must inform you about the value of having a pre-determined or guaranteed stop loss order (GSLO) for each fx trade.   There are some traders that adhere to a philosophy that investors should never setup a pre-defined stop loss, but they should apply an invisible stop loss or free floating stop loss during each transaction.  These traders believe that price action alone will determine when it is necessary to exit a position.  Although there is some truth to this principle, the unfortunate reality is most traders allow their emotions and psychological bias to tie them down to positions that are in reversal.  Without a guaranteed stop loss order, traders will remain in losing trades for much longer than is needed, and this ruins the risk/reward estimate that all profitable traders should be targeting during each trading setup. One of the misconceptions about stop loss orders that must be debunked is that it damages your trading efforts whenever they are triggered.   Some forex traders adhere to the philosophy that all stop losses are bad and traders should avoid any chance of being “stopped out” of a trade prematurely.  Although the preferred goal is to place trades that never hit your stop loss, the triggering of a stop loss is actually a good thing when looking at risk-to-reward.  Stop loss orders actually enhance one’s overall trading profits in the long run, and is simply a means of managing risk and preserving capital. Whenever price hits your stop loss order, you must convince your mind that this is good for your trading business because you’re applying a method of trade maintenance that will help to keep your business afloat for a lot longer than some careless investors out there.  So, stop loss strategies are not evil, but they are good.

Stop loss rules can be expressed in a variety of ways, such as:

  • A fixed dollar or pip amount. An example of this type of stop loss order is when you risk 100 US Dollars or 100 pips for every trade. Usually it’s preferred that forex traders allow the market environment to determine the optimal point to leave a position, rather than using an arbitrary Dollar amount.
  • A trailing stop. The same principle applies here as well. Automatic Trailing stops usually don’t take into consideration the day-to-day shifts in market dynamics.
  • A stop adjusted to volatility. This means applying wider stops during highly volatile periods and using tighter ones during tranquil or thin markets.
  • A time stop is an automatic stop loss order that will get you out of a trade and free your capital as soon as the market becomes very choppy.
  • A technical level dictated by an indicator, a combination of indicators or a price level identified on a chart. Although this is the most difficult way to place stops, it’s also the smartest.

As you can read above, I only listed a very small list of stop loss options that will ensure traders a profitable outcome or means to preserve their capital.
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About the Author Marvin Perry

Marvin Perry has been an active trader within the Forex market since 2010. He attended the University of Illinois in Urbana/Champaign, and graduated in 2002 with a double major in Cell and Structural Biology and Chemistry. He currently serves as an FX instructor & Quantitative Analyst for the Forex Anatomy Private Trading Community called "The Lab", where he conducts live weekly trading webinars & instruction on Fundamental Analysis & Inter-Market Interpretations of dynamic asset classes and their influence on currencies.

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