Stop Loss Strategies to Protect Your Forex Portfolio
Trading is a game where the best form of attack is to defend. Your first line of attack is to make sure you can trade another day. That means you must defend your portfolio first before seeking huge profits. The only way of defending your portfolio is to have a stop loss strategy you are comfortable with. There are several ways of setting a stop loss. Here are some of them.
Percentage of account
You can choose a percentage of your trading capital you can comfortably risk in each trade without losing your cool. Then calculate the dollar amount. With this dollar amount, you can calculate how many pips your stop loss can be for whichever lot size you wish to trade. For example, if you have a $5000 capital and wish to risk 1 percent of it per trade, that means you’re going to use $50 per trade. At $1 per pip for 0.1 lot, you will have a 50 pips stop loss if you trade 0.1 lot or 25 pips stop loss if you trade 0.2 lot.
Market structure-based stop loss
Most traders prefer setting their stop loss based on the structure they can see in the market. This means setting it beyond important levels in the market such as previous swings high/low or beyond the tools they used for analysis such as moving averages and trend lines. This surely makes sense because it is based on what the chart says. There are several ways you can set your stop loss from what you can see on the chart. Here are some of them
- A Few Pips Beyond important support and resistance levels: Since price finds it hard pushing through these levels, setting your stop loss some pips beyond them makes sense. Should price finally break out of the level, you would know that it really means business and no point messing around with it.
- A few Pips Beyond Fibonacci levels: Some Fibonacci levels like 38, 50, 61, 76, 100, and their extensions can be good levels beyond which you can set your stop loss order. Price struggles with these levels too.
- A few pips Beyond the Main Trendline: You can set your stop loss a few pips beyond the trendline at the point of entry. Trend lines are also great for trailing your profits when you’re in one as they act as dynamic support/resistance levels. You keep moving the stop a few pips beyond the corresponding part of the trend line.
- A few pips beyond price swing highs/lows: One of the traditional ways to place stops is placing them some pips beyond the high/low of the current or preceding price swing.
- A few pips beyond a major moving average: An important moving average such as 200-period moving average acts as a dynamic support/resistance just like the trendline. Stop loss can be placed beyond the part of the moving average line that corresponds to the current price.
Volatility-based stop loss
Another good method of placing stops which most big financial institutions use is the volatility-based methods. These methods take into consideration, the recent volatility in the market. Some of the indicators they use to track the market’s volatility include the average true range, Bollinger bands, and standard deviation.
Average true range (ATR): This measures the average price range per unit period over a selected number of periods. There are many ATR-based stop loss indicators out there that follow price movement in a stepwise manner. You can get one and place on your chart to guide you in placing stop loss orders.
Bollinger band: This also measure volatility. Though not a common practice, some traders feel comfortable placing their stop-loss orders some pips beyond the upper or lower Bollinger band as the case may be.
Standard deviation: Placing stop-loss orders beyond the two standard deviation of the average price is not an uncommon practice among traders. You can get a standard deviation indicator or use the standard deviation channel in your MT4 as a guide.
Time-based stop loss
Have you been in a trade and after several hours or days — as the trading style may be — the price hasn’t gone anywhere or, it may even form an opposite setup and starts moving against you? I bet that even though the price hasn’t gotten to your stop loss level yet, you may wish to get out of the trade then than take a full loss. Just as the name suggests, time-based stop loss is setting a time to exit a trade if it hasn’t become reasonably profitable for you to set your stop at the breakeven point. It is a strategy you may want to combine with your other stop-loss method for a better trade management plan.
Setting stop loss is essential for your trading longevity. We will lose money in some trades but we always want to limit our trading losses to a controllable level. Protecting your account is your number one goal in trading. There are many stop-loss strategies you can employ to do that. Remember, if your account is alive, you will see more opportunities to trade; the more opportunities you trade, the more chances of success and the more chances of success comes more chances of losses too. Stop loss strategy is just as important as your trading strategy.
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