Stop Loss Forex Order

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Stop Loss is an essential trading tool to safeguard your trade capital and eliminate the chances of massive losses in the financial market. However, before using these orders, it is essential to understand its concept. In this article, we will learn about forex stop-loss orders with types, benefits, limitations, and how to use them effectively.

What is Stop Loss?

Stop Loss is a market order to buy or sell financial assets while limiting potential losses. Under this, traders set a limit to close a position when the price moves against their prediction.

A buy-stop order is executed when the market moves against you and the price of a particular asset falls and reaches that level or below. In contrast, a sell-stop is executed when the price of an asset reaches that level or rises against your prediction.

Stop Loss Forex Order Example

In the Financial Market, the price of an asset rises or falls due to different market conditions like economic reports, significant events, central bank policies, inflation, trade balance reports, etc.

Traders analyze and interpret these fundamental and technical factors to make buy or sell decisions. However, no one can predict the market with 100% accuracy.

So, traders must be prepared for situations when the market moves against them. In such cases, they can use stop-loss orders and limit potential losses.

Let us understand how to place a stop-loss order with example. Suppose a trader has bought EUR/USD pair at 1.1150 and set the stop loss limit at 1.1145.

However, his prediction went wrong, and the price fell to 1.1140. In this case, he doesn’t need to worry as his order will automatically close at 1.1145. So he has saved five pips using a stop-loss order.

Types of Stop Loss

Guaranteed Stop Loss

It is the most critical risk management tool usually provided by the forex broker to protect clients against significant losses.

Under this, the trade will automatically close at the stop loss level even if there are gaps or jumps and the price does not reach the specified level.

Suppose you have bought EUR/USD at 1.1125 and set the stop loss at 1.1120. However, the price fell unexpectedly and reached 1.1116. In this case, the price does not reach 1.1120, but as we have used guaranteed order, this gap will not affect your trade.

Trailing Stop Loss

This type of stop loss is used to adjust the stop loss level when the market moves in favor of the traders. In simple words, with trailing order, the stop loss level also moves when the price moves in your favor.

However, the stop level remains unchanged when the market moves against your prediction.

Percentage-Based Order

As the name suggests, a trader uses this type of order based on the amount of capital they are willing to lose. So they take risks based on percentages like 1% or 2% per trade.

Traders set the stop loss level for all trades based on the risk percentage. However, the method is not suitable as while setting the stop loss level it is important to consider market conditions instead of predefined rules.

Stop Loss Forex Order

How to Select the Stop Loss Level

We have discussed the meaning and importance of stop-loss orders. However, the most common question of beginners is how to decide the level for stop loss.

Placing a stop loss level unreasonably without proper planning may have negative outcomes. Let us look at a step-by-step procedure for selecting a stop-loss price.

  • The first step is to select a currency pair and identify the right trading opportunities to invest in.
  • Secondly, conduct fundamental, technical, and sentimental analysis to analyze and interpret conditions to stop loss accordingly.
  • Use reliable forex signals to get pivot information like entry, exit, support, and resistance levels. It is advisable to place a stop-loss order beyond the support and resistance levels.
  • Consider your risk-to-reward ratio before placing this order, as it will help you to stay in a consistent position and eliminates the chances of heavy losses.
  • With the above things, consider market volatility, liquidity, trading session, time frame, strategies, and other factors to select the proper stop loss level.
  • After careful analysis and interpretation, you can set a stop loss level. Remember to set a logical level, otherwise, your trade may close at a premature time.
  • Also, if you are a beginner or using these kinds of orders for the first time, you can go with demo trades to determine whether this order suits you. You can use your stop-loss strategy in real trades once you are satisfied with the demo results.

Benefits of Stop Loss Forex Orders

Manage significant losses

Trading in currencies may result in profit or Loss. However, an intelligent trader is one who stays prepared for the worst and takes necessary precautions for loss management.

Using a stop-loss order will not eliminate the chances of losses. However, it does reduces the amount. This order enables traders to risk the amount they can afford to lose.

Automated Process

The best part about the process is you don’t need to continuously monitor the market in order to close the trade. It will execute automatically when the price reaches that level.

So, even if you forget to close the trade or get stuck in an important meeting, the order will automatically be closed at predefined conditions.

Emotional Balance

Using this type of order will give birth to confidence, discipline, and logical decision-making. A trader already knows the maximum amount he can lose from a trade.

So even in adverse market conditions, a trader can manage to stay in a stable position without excessive fear or guilt.

Limitations of Stop Loss Forex orders

Early Exit

The stop-loss order is all about limiting the losses, but you need to understand that it will also affect your profit. During a higher volatility period, it may be possible that the trade will close early, and you didn’t even get a chance to play.

As a result, you may miss an opportunity to make a good profit. Also, there is a lack of flexibility with the market conditions as your closing point is predefined.

Technological Error

Stop Loss Order may not be executed at the intended level due to poor internet connections or any other technological errors which may result in heavy losses.

However, it happens rarely, but you cannot depend entirely on automation, and you have to keep an eye on your trades to eliminate the chances of such glitches.

Gaps or Jumps

Forex trading offers great volatility, meaning the price of currency pairs changes frequently. Higher volatility results in great trading opportunities.

However, it also results in unexpected price slippage, gaps, or jumps in the market. So with regular stop-loss orders, the price may never reach to speculated level.

Conclusion

Stop loss forex order is a valuable tool for risk management in financial trading. A trader should always trade using such order to manage significant losses.

However, using a stop loss order is not enough; effectively selecting, the stop loss level is also necessary; otherwise, the whole result will be affected. It is essential to conduct proper research and place stop loss limits considering the market conditions.

Stop Loss may have certain limitations and impact on your overall profit. However, remember you are putting your hard-earned money in the market, so it is important to take some precautions.