Posted by forex at 2:25 AM
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1. Have a trade plan. Trade plans or strategies should include an action step regarding stop losses. Whether a trader is a position trader, day trader or scalper will influence how the stop loss aspect of his trade plan is determined.
2. Have a risk management strategy. A risk management strategy is a predetermined level of tolerable risk per trade and per account. This risk management strategy speaks directly of account leverage, your risk-to-reward ratio for each trade executed, the number of simultaneous open trades and the total amount of your account balance tied up in open trades. To ensure that your risk management strategy is enforced, stop loss orders must be attached to every open trade to avoid losses beyond that predetermined risk level. That means there is no one formula for setting a stop loss. The reward potential for each trade entered, plus the risk management strategy, will dictate where a stop loss order should be placed for that specific trade.
3. Enter trades that match your risk management strategy. No matter how confident you are about the direction of a potential trade, if the cost of entering that trade does not match your risk management strategy, pass on the trade. For example, if your stop loss for a trade is -130 pips away from your entry and your risk management strategy says your stop loss order should not exceed -50 pips, pass on the trade or look for a less risky entry that matches your predetermined tolerance for risk. Ignoring your stop loss plan means an exposure to a higher level of risk and should that loss happen, the result could be devastating to the account and to the trader's accountability for that account.
4. The minimum risk to reward ratio should be 1:1, which means that if the trade is calculated to have a possible 30 pip gain, then the maximum risk you should take is a possible -30 pip loss. Of course the higher the reward to risk, the better; for example, risking -25 pips to get 50 is a 1:2 risk to reward ratio, or risking -25 pips to get 100 is a 1:4 risk to reward ratio. There is no point taking a chance of losing 50 pips to only gain a possible 30 because if that trade goes against you, you just might lose those 50 pips, putting you behind by 20 pips.
5. Don't move your stop loss order once in place. This is favorite mistake of many losing trades and unsuccessful traders. Having entered a trade with happy expectations of profit, the trade moves into a loss position and is steadily moving to fill your stop loss order. Rather than allow the stop and accept the loss, many traders move the stop loss to an ever riskier amount with fingers crossed that the losing trade will magically turn around and deliver a profit. Instead of losing a possible 50 pips as originally ordered, the stop loss is moved to a negative 100 pips. If the trade continues to move negatively--since magic rarely happens in the trading world, then instead of losing 50 pips, the loss is now a staggering tear-jerking 100 pips. If your risk management strategy predetermines your stop loss at any level, never move that stop loss order after a trade is executed.
6. Some traders enter all trades with a fixed stop loss order. For example, every trade has a default of, say, -35 pips. However, 35 pips might be within the retracement or pull back zone of the current trade's normal movement, potentially stopping out before the trade moved to the exact goal you had in mind. Some traders may have a stop loss range of up to -50 pips, for example, so if -25 pips will allow the trade room to move while limiting their risk, then they are not going to enter-50 pips just because -50 pips is their tolerance level. Again, each trader needs to find a style or strategy that matches their risk tolerance. The best advice is to trade according to your plan, and if the trade opportunity does not match your risk management strategy, pass on that trade.
7. Adjust your time frame. The larger the time frame, the larger the risk. Charts showing data in one hour increments demand larger risk tolerance than charts showing 15 minutes of data. Placing your stop loss a few pips away from the last high or low means your stop loss will be more pips away than if you had used a shorter time frame. Sometimes keeping your risk management plan but executing your trades on a shorter time frame may be an effective way to lower your stop loss in pip value, while staying within the parameters of that plan.
8. Cancel and replace. Stop loss can also be a strategy to preserve profit. If you are in a trade that still has an opportunity to offer more profit, moving a stop loss forward can help to secure profits already earned, so if the market reverses, you keep the profits up to that point. To use this strategy, after entering the trade, if you have secured profit, simply move your stop loss up to the next point that guarantees you keep some of your profit while still staying out of the way of the trade in play.
9. Use trail stop. Consider using a trailing stop that continually moves your stop loss forward as you gain profit, locking in your profit as you go. Of course, just as in all the steps before, keep this trail well out of way of the trade in play allowing for the normal up, down, sideways movement of the market to happen without stopping you out of a trade that is going your way. Sometimes a trail stop allows a trader to gain more pips than entering a limit order, otherwise known as a take profit order. The trail stop can therefore be an effective stop loss option to manage risk and secure profits already earned.