Understanding Forex Trading – What Is Stop Loss

In Forex trading, knowing where to place stop loss is a major ingredient for success. A good number of traders neglect this essential aspect of trading and end up causing a lot of unnecessary damage to their trading accounts. Stop loss refers to an order placed in the market to prevent you from incurring losses if price goes against you. When in a long position, a stop loss order is usually placed some distance below the point of entry. And, when in a short position, a stop loss order is usually placed some distance above the point of entry.

There are various methods you can use to set stops, some of which are equity stop, volatility stop, and chart stop. Equity stop, also referred to as percentage stop, is the most common type of stop and it uses a predetermined fraction of a traders account to compute the distance the stop loss order should be placed from entry. For example, you can be willing to risk 3% of your account in a trade; thus, you will use this position size in computing where to place your stop loss order.
Volatility stop refers to placing a stop according to the amount a market can potentially move over a given time. This method ensures the right stop loss levels are placed so as to prevent being taken out of a trade due to the random rise and fall of price. For example, if you are using the swing trade strategy and you want to trade the EUR/USD, you will not place your stop loss at 20 pips. This is because EUR/USD moves by about 100 pips each day.

Chart stop is placing stops according to what the charts are saying. A good way of achieving this is placing stops based on significant support and resistance levels. When you place stops beyond support and resistance levels, you can rest assured that your stops cannot be hit because they can potentially hold price from pushing through them.
In conclusion, stop losses are of essence in cutting down your losses when trading currencies. Regardless of what the market does, if you have a correctly placed stop loss order, you wont be spending sleepless nights. The Forex market is usually very dynamic in nature, so you never know when price will turn against you. Therefore, it is important to put some preventive measures in place. Or, is prevention better than cure?