As a trader, your most important responsibility is to manage and preserve your trading capital.
If you lose all of your trading capital, there is no way to recover your losses; you are out of the game.
If you make pips, you must be able to hold them and not return them to the market.
But, let’s be honest. The market will always do what it wants and move in the way it wants.
Every day presents a new challenge, and practically anything from geopolitics to unexpected economic data releases to central bank policy speculations can shift currency markets one way or the other faster than you can clap your fingers.
This means that we will all eventually take a position on the wrong side of a market shift.
Being in a losing position is unavoidable, but we have control over what we do when we find ourselves in it.
You can either cut your losses soon or ride it out in the hope that the market will turn around in your favor.
Of course, that one time it doesn’t go your way might wipe out your account and put a stop to your promising trading career in an instant.
Every trader on Newbie Island should live by the mantra “Live to trade another day!” because the longer you can survive, the more you can learn, accumulate experience, and boost your chances of success. As a result, the trade management strategy of “stop losses” becomes an essential skill and tool in a trader’s arsenal.
Having a planned point of exiting a losing trade not only allows you to reduce losses and move on to fresh opportunities, but it also minimizes the worry that comes with being in a losing trade without a plan.
Isn’t it true that less stress is better?
Of course it is, so let’s get to the many ways to quickly cut ’em losses!
Before we go into stop loss tactics, let’s go over the first guideline of stop setup.
The “invalidation point” of your trading notion should be your stop loss point.
Do you recall the last time you went on a blind date? You had had enough and just wanted to leave at some time. In the dating game, that’s a dead end.
However, a stop loss in the trading game is not that dissimilar.
When the price reaches this level, it should tell you, “It’s time to get out, buddy!”
Why Use a Stop Loss?
The main purpose of a stop loss is to ensure that losses won’t grow too BIG.
While this might sound obvious, there is a little more to this than you might assume.
Imagine two traders, Kylie and Kendall.
They both trade the same exact trading strategy with the only difference being their stop loss size
|Stop Loss Size
(% of total account balance)
For each trade, the trading strategy only has two possible outcomes:
This means that the strategy exits a trade when the stop loss (SL) is hit OR when the profit target (PT) is hit.
Now imagine that both Kylie and Kendall go on a losing streak.
They both lose TEN trades in a row!
Kendall’s account will be down 20% BUT Kylie’s account has blown her account!
Kylie is out of the forex game.
Using a stop loss decreases the risk of blowing your account and work to protect your trading capital.
In the next section, we’ll discuss the many different ways of setting stops.
There are four methods you can choose from: