Learn to use Stop Loss effectively

Learn to use Stop Loss effectively

Every day hundreds of traders blame themselves for being so naive and trading without protective stops. Hundreds of others lose funds worth weeks, months, years of trading just only in one very unsuccessful trade.

And yet another hundreds of traders, having heard dozens of times about importance of protective stops, open new trades ignoring recommended money management rules.
Stop loss is not a favorite tool for many traders as it requires taking necessary losses, calculate risks and foresee price turns. However, such money management tool in hands of a knowledgeable trader becomes rather a powerful trading weapon than a tool of disappointment and painful losses.
Every trader is free to develop or choose his / her own trading style and implement money management rules. We will go over several methods of using a stop loss tool.

1. Simple equity Stop
It's an important money management rule: not to risk more than 2-3% of the total account per one trade. According to this rule, a trader would place an order and based on a lot size would calculate amount of pips required to reach the limit of 2-3% of the total account balance (and a stop loss will be placed at that point).
For example: a trader has 1000 USD on account, he places a buy order of 4000 units on EUR/USD, which will give him 0.40 cents per 1 pip. Since 2% (out of 1000 USD) that he is willing to risk equals 20 USD, calculations will be next: 20 / 0.40 = 50 pips is the limit for this size of trade.

2. Chart based Stop
Adopted by many traders, this stop relies on different chart patterns, indicators and signals received when using technical analysis of price moves at any given time. There are many styles, rules, techniques on how to and when to use a stop loss, associated with different technical indicators and different trading systems.
There are many approaches to placing protective stops: stops based on swings high / low, stops using trend lines, fibonacci related stops, etc.
Let's take a look at some examples below:

Stop based on last swing low (double-bottom pattern)



Chart based stops are widely used in combination with simple equity stops.
3. Margin Stop
It represents one quite interesting approach that would rather suite traders, who like placing all money at once on a particular trade. But at first, the trader should divide his account into several equal pieces to ensure that the whole capital will not be blown off in one shot. Supposing that a trader plans to spend 15 000 USD, it is suggested that the account opened with a broker "weights" between 1000 to 2000 USD.
Then a "play" with a margin starts. Depending on the leverage that is going to be used and carefully choosing a lot size, a trader can calculate the point where a margin call will occur.
This point will work as a global stop loss, which if crossed will cause the account to be closed automatically.
A predetermined risk, no concerns about the manual stop loss, a maximum trading position size — all that creates the whole new approach to trading on Forex market.

4. Volatility related Stop
Price volatility can also be used to set a stop loss. During active hours with a high volatility market, a stop loss must be set further than usually to eliminate seldom noise of the price moves and react only on major changes. During low volatility market, a protective stop should be placed closer to be able to react in time when the price starts showing serious changes.
One of the good technical tools to measure price volatility is a Bollinger band.
Let's take a look at the following example:


5. Protective stops are extremely important during huge rallies
Simply because too many traders react on those "rally events", one can face a situation when it becomes impossible to get to the trading platform to close the order or place a protective stop. At such moments servers are overloaded and therefore traders' online platforms can work with huge delays or not respond at all. In such situation traders become helpless while money is draining away of their accounts. The only option here would be to call the broker and make voice orders. Again, there will be no guarantee that brokers aren't overloaded with calls at this moment as well, and so trader should wait... dreaming how simple things could be if a stop loss was there.