How to set a stop loss in foreign exchange trading

Summary: Many investors know they need to set a stop loss, and if they don't know, they will learn it quickly in the market. Market movements are unpredictable, and stops are one of the tools to prevent investors from being ruined by a single trade.

When investors start learning to trade, one of the main goals is usually to find the best trading system. However, no trading system can be profitable most of the time, resulting in many beginners failing to achieve their trading goals. Therefore, beginners need to learn risk management or money management so that when they know they are going in the wrong direction, they can control losses and maximize profits when they know they are going in the right direction.

We have done statistics on FXCM's clients, and the results show that investors often correct the direction of each currency pair more than 50%, but end up losing money. The reason is that their profit on the correct order is much smaller than the loss on the wrong order. This shows the importance of the correct stop loss for our risk management. Here is how to set a stop loss.

Set a static stop loss

An investor can set a static stop loss that does not change its position until a trade hits a stop or limit. The advantage of this setup is that it is simple. Investors must ensure that their risk-reward ratio is at least 1:1.

For example, let's take a look at a short-term investor in California who entered the market during the Asian session and expected that the volatility of the Asian or American session would have a greater impact on his trading. Considering the recent volatility, he set a 50-point stop loss. Setting a stop loss is a very simple operation on the FXCM trading platform.

Set a static stop loss according to the indicator

Some investors will set a static stop loss based on some indicators, such as the average true volatility ATR. The main benefit is that investors use current market information to help them set stops.

So if an investor sets a 50-point stop loss and a 100-point limit, what does this mean in a volatile market and a calm market?

If the market is calm, a 50-point swing will be relatively large, while if the market is volatile, the same 50-point swing will be relatively small. Using a measure of market volatility such as ATR, investors get the latest market information.

Trailing Stop

The use of static stops can greatly improve the trading performance of beginners, but other investors use the concept of stops to further optimize their trading performance, that is, the use of moving stops.

A trailing stop is a stop that moves with the market as the trade moves in the investor's favor, thus reducing risk. For example, if an investor is long EUR/USD at 1.3100, the stop loss is set at 1.3050 and the limit is set at 1.3200. If the exchange rate rises to 1.3150, the investor can raise the stop loss to 1.3100.

If the stop loss is adjusted to the entry level, then if the EUR/USD reverses, at least the investor will not face losses when the unfavorable trade, at which point the investor can set the risk on other trading opportunities, or enjoy the risk-free EUR/USD bullish opportunity. But if the EUR/USD rebounds to 1.3190, will we become more greedy? In this case, we can move the stop loss and limit together. You can raise the stop loss to 1.3150 and raise the limit to 1.3300 at the same time.

Zoom in according to the picture, and dynamically move the stop loss.

There are many ways to set a trailing stop, the simplest is a dynamic trailing stop. With a dynamic trailing stop, the stop will be adjusted accordingly every time the market favors the investor.

Taking the EUR/USD as an example, if EUR/USD rises from the entry point of 1.3100 to 1.3101, then the stop loss will be raised from 1.3050 to 1.3051.

Fixed moving stop

Investors can also set a trailing stop through the trading platform. For example, an investor can move a stop loss every time the market trades 10 points in favor of the investor. Or take the EUR/USD as an example, when the EUR/USD rises from 1.3100 to 1.3110, adjust the stop loss to 1.3060. And if the EUR/USD rises by 10 points again, the stop loss will be raised to 1.3070.

This way, if the market reverses, investors can stop their losses at 1.3070 rather than at the original level of 1.3050.

manual moving stop

For traders who want to control their trading situation, it is possible to move the stop loss manually. I prefer this because I am more concerned with the volatility of the exchange rate, and many strategies focus on trends and rapidly changing markets.

We mentioned this management method in our previous article on the use of price fluctuations to set moving stops in trending markets. Investors can watch swing lows or highs during the uptrend or downtrend. In an uptrend, when the exchange rate creates higher highs and lows, investors can raise their stops below the higher low. Once the exchange rate falls below the higher low, investors can seek opportunities to exit.