How to Set Stop Loss Orders in Forex
Setting stop loss orders in forex trading is an essential tool to minimise risk and reduce the chances of missing out on potential profits. Photo: Nicholas Cappello/Unsplash
A stop loss order is one of the most important tools when it comes to forex trading. This risk management tool is a pre-set order that automatically closes a trade when the market reaches a specified price. It provides value by helping to control potential losses.
Establishing Stop Loss Orders
A key starting point for setting stop loss orders in forex is to use one of three methods to decide what your stop loss level would be. These include:
- The percentage method (which described setting a stop-loss at a specific percentage below the purchase price);
- The support method (identifying the most recent support level of the most recent support level of the currency pair and placing the stop-loss just below that level); and
- Moving average method (where the stop-loss is placed just below a longer-term moving average price).
Let’s review the steps that will help you determine where to set your stop loss level.
What to Consider When Placing a Stop Loss Order in Forex
1. Use Swing Low to Inform your Trading Strategy
Your first consideration should be to place your stop loss order below a swing low. A swing low is a low point where prices are at their lowest. Some traders might use a weekly timeframe as an indicator of swing low, while others might look at the lowest price per month.
2. Be Mindful of Volatility and Resistance Levels
As a trader, you need to consider the unpredictability of the currency pair you are trading and use established support and resistance levels as strategic stop-loss levels.
3. Set Trailing Stops
A trailing stop loss order is a type of order that sets the stop price at a fixed amount below the market price, with an attached “trailing” amount. When the market price rises, the stop price increases by the trail amount. However, if the stock price falls, the stop loss price doesn’t change. This process allows investors to specify a limit on the maximum possible loss without setting a limit on the maximum possible gain.
4. Know What your Risk Tolerance Level is
Traders should assess their risk tolerance, as it influences the level at which stop-loss orders are placed. A low risk tolerance may lead to tighter stop-loss levels, while a higher risk tolerance may allow for wider stop-loss levels.
Wrapping Up
Setting stop loss orders in forex trading is an essential tool to minimise risk and reduce the chances of missing out on profits. Although stop loss orders are not 100% risk-free, they essentially assist traders in managing their funds, ensuring that they are aware of what they are willing to risk with any trade.
