Some traders use them, some traders don’t. I use do them, and in this article i am going to explain why setting stop losses will make you a better trader.
What are stop losses?
For those of you that are very new to trading, stop losses are pending orders placed in the market, to close a position at a certain price point, if a trade goes against you.
Stop losses are exactly that, they stop you from being exposed to significant losses if you get it wrong.
Many traders do not fully understand when it is safe to enter a trade, so they often get into the market at the wrong time, and a stop loss is used to limit a traders losses if the trade moves too far from the entry position, to a level where the trader feels that the trade will not be a successful one.
How are stop losses used by the majority of traders?
The majority of traders to do not have a clear understanding of the market, and are therefore entering trades based on how much they are prepared to lose on a trade, rather than how much they can profit on a trade.
A professional trader will always look at a trade from a profit point initially. A professional trader will understand the market, and will see a profit target first before he sets his stop loss.
A typical retail trader will set a stop loss of anything from 10 to 30 pips from their entry point, and they will target a risk reward ratio of at least 2 to 1. So their profit target will be anything from 20 to 60 pips.
Now if you are reading this and thinking yes that’s me. That’s what i do, but i always seem to get stopped out. Whether i set a 10 pip stop or a 30 pip stop i always seem to get stopped out, it just takes a bit longer if i use a 30 pip stop.
Why the majority of traders are getting stopped out.
The simple answer is they are entering the market at the wrong time. Think about this statement.
The market does not care where you enter, and it does not care where your take profit is. The market will do its thing and you will either get stopped out, or price will hit your take profit.
Traders that are getting stopped out more often, tend to use bigger stop losses to avoid the stop out. But if you increase the size of your stop loss, you also have to increase your take profit target. So if you are using a 2 to 1 RR, a bigger stop loss will mean a bigger take profit, and if you are targeting a bigger take profit, the sentiment of the market has more time to change before your TP is hit, and your trade has less chance of working out.
So how can you avoid being stopped out before your take profit is hit?
The answer for the majority of traders is to trade without stop losses. I have been trading professionally for quite a few years now and i have seen many changes in the market, but one of the most significant changes that i have seen, is how many retail traders are now trading without stop losses.
If you want to see your money go down the toilet, trade without a stop loss.
Why are retail traders trading without stop losses?
The main reason is because they do not want to lose their money, but another more interesting reason is they think that if they put a stop loss in the market that is visible to their broker, then it will be easier for the broker to stop them out if they know where their stop is.
Many retail traders talk about stop hunting, and say that if your stop is visible to your broker he will hunt you down and stop you out. This is complete rubbish. No broker is going to move the market to get your 100 bucks. Do you know how much money is costs to move the market 1 pip? Why would a broker spend millions for dollars trying to move the market to get your 100 bucks?
Trading without a stop loss is not the way to be successful in the Forex business. Trading success is about entering the market at the correct time. If you do this then the chance of you getting stopped out is greatly reduced, and your trade is more likely to hit your take profit.
Why i prefer to use stop losses.
To benefit from the use of stop losses you first have to learn how to trade, so you are entering the market at the correct time. When you know how to trade, a stop loss is very important because it takes the emotion out of trading.
When you enter a trade with a stop loss, you are limiting your risk, so if you are comfortable with your risk, and your potential reward, then you are trading based on a calculated trading decision, and not on an emotional hunch.
Traders that trade without stop losses are emotional wrecks, as they do not know their potential loss in advance, so they are glued to the chart, hoping and praying that the trade works out before they lose their shirt.
This is not how professional traders trade. Professional traders take calculated risks based on high probability trade set ups. They set a stop loss, and a take profit that they are comfortable with, based on a clear understanding of the market and its participants. When the stop loss and take profit is set, they move on to another trading opportunity.
Set and forget.
Although i am not a great fan of set and forget it does take a lot of the emotion out of trading. I tend to use a set and monitor strategy rather than a set and forget. The market is constantly changing and i believe that you have to monitor your trades as the market changes. You may need to tweak your stop a little, or your take profit, to maximize your potential reward, and limit your potential risk.
Setting stop losses will help you to become a more successful trader.
Setting stop losses takes the emotion out or trading.
Setting stop losses enables you to set and forget. Or as i prefer set and monitor.
Setting stop losses helps you to protect your capital.
Setting stop losses means you can move onto new trading opportunities, and not sit glued to the chart all day.
Setting stop losses gives you your life back. If you want to go for a walk, or go and grab some lunch you can do, because you have the protection of a stop loss, and you are comfortable with your risk.
The most important thing to take from this article is stop losses will only work if you are entering and exiting the market at the correct time, and that is the holy grail of trading in my opinion.
