In this article, we will look at the features of using protective stop loss and trailing stop orders to improve your Forex trading skills and avoid unnecessary losses.
On June 23, 2016, voters in the United Kingdom of great Britain went to the polls to decide on the future of the United Kingdom in the European Union. When the day ended, the results shocked many people, as the UK, the second-largest economy in the EU, had just decided to leave the world’s largest free trade agreement. When the markets opened, the pound showed one of the most significant falls in its value in history. This was due to the fact that before the vote, most polls showed a clear victory for voters who want to remain in the European Union.
For the few traders who foresaw such a vote outcome, June 27 was a very profitable day. For the majority of traders who followed the results of surveys, this day ended much less successfully. There are stories of traders who lost all their funds buying pairs with the pound sterling as the base currency.
The Brexit vote is a good example of why traders take risks every day. To minimize the impact of these risks, experienced traders use a combination of methods. For example, some traders adjust their leverage ratio when they expect important economic or political news to come out. Other traders focus on opening small trades, while others remain completely out of the market during periods of high volatility.
A common method of reducing risk in Forex trading is to use a stop loss order. Stop loss is a tool that can be found in most trading platforms, it helps traders manage risks. Stop loss automatically stops trading when a certain level is reached, even if the trader is not present in front of the trading terminal. Usually, the stop loss level is determined by the maximum Deposit amount that the trader is willing to lose. By using a stop loss, traders avoid a situation where one failed trade wipes out all their previous winnings. Thus, a stop loss is triggered, automatically exiting the trade when a certain level of loss is reached, even if the trader is absent.
How to set a stop loss?
To set a stop loss, the trader must do several things. First, it must calculate the ratio of risk and profit. This is a simple ratio that determines the maximum amount of Deposit that he is willing to lose, and the maximum profit that he wants to get. Although there is no consensus on the optimal risk-to-profit ratio, the ideal ratio for beginners is 1:2. With this ratio, a trader risks one dollar to potentially earn $ 2.
To determine the ideal risk-to-profit ratio, experienced traders use a simple formula that takes into account the ratio of their profitable transactions. This formula assumes that the current level of profitable trades of the trader will be maintained for future transactions.
Formula: E = (1 + (W / L) × (P-1), Where: P is the profit coefficient, W is the average profit, and L is the average loss.
For example. If a trader makes 10 trades, makes a profit in 6 of them, and suffers a loss in the other four, the profit ratio is 60%. If six profitable transactions bring in $ 3,000, this means that the average profit is $ 500. If the loss-making trades totaled $ 1,600, the average loss is $ 400. Applying this data to the above formula, we get 35%. This means that this trader’s Deposit will be relatively safe when using the 1:3.5 ratio.
When placing a stop loss during day trading and trading on fluctuations in the currency market, traders are recommended to use two methods. The first method is using the two-day minimum method. With this method, you should place a stop loss of about 10 points below the two-day minimum of the pair. For example, if the minimum of the most recent GBP/USD candle was 1.1500 and the previous minimum was 1.1400, the stop loss should be placed at 1.1390 if the trader places a buy transaction.
The second option that is recommended for traders is to use the Parabolic Stop and reverse (SAR) indicator. This indicator is found in most trading platforms, including MT4. The indicator puts a point on the chart where the stop loss should be set when a trader opens a long trade.
Other options are also possible, such as using Fibonacci levels, Bollinger bands, and other technical indicators. A trader needs to find a formula that works, test it, and apply it to their trading.