Forex trading is a very profitable business but it can be also a very risky business that is if proper money management is not employed. If a Forex trader don’t make proper use of stop loss placements and trailing stop loss or take profit levels, he will be taking on high risk which means that any trades may bring his equity account to the risk of ruin. These tools are very essential, and it is very difficult to make profit in Forex without making proper use of these tools.
What are stop loss orders?
It is a type of order which will automatically close a trade at a set level in order to prevent further losses. Often, it is used as a safety precaution and is most needed when a trader made a bad trade.
For instance, say you just bought the EUR/USD at 1.4000 because you expect the euro to appreciate and reach 1.4100 (+100 pips) in the short term. You want to protect yourself by placing a stop loss below 1.4000, say 1.3980, so that if the price does not go your way the trading platform can automatically close the order to prevent you from losing more than 20 pips.
Stop loss orders not only free the forex trader from the computer, it forces him to limit his losses prior to making the trade by way of money management.
While placing stop loss is one of the sound principles of money management, on the other hand, it may cause some trades to hit the stop loss, this is often called a stop out. This is one of the most cited reason why beginning traders are afraid to place stop loss. Another reason will be because of a broker’s (scammer in disguise) stop loss hunting activity (it is most important to stick with a regulated brokerage company)
Trading Insurance For Forex Traders
A stop out by the price hitting the stop loss will cost the forex trader money just like the cost of insurance, but the trader didn’t lose it all and he can regroup and relook at his trading performance at the end of trading day. Stop loss is like an insurance policy- property insurance insured the property and indemify for losses.
In the event that the house is damaged, the insurance company will indemify the losses and the money can be used to rebuilt the house and help the owner overcome emotional shock and financial troubles.
Ensuring a stop-loss is placed in every trade is the first step to proper money management. Putting a money management plan into place may create some additional costs in both time and money. But these costs can work to a trader’s advantage in the same way like paying for a monthly insurance premium cost can protect policy owner against catastrophe for a variety of situation in day to day life.
By implementing a stop-loss is like an insurance policy, a trader is protecting himself from the worst-case scenario, limiting his risk and ensuring that his equity account will not be completely devastated in the event of a catastrophic event that he has little or no control over. Basically, it means that he can come back to trade another day.