A stop loss order is a sell order, usually for equities, which is executed best when the current price reaches or falls below a price set by you.
How STOP LOSS works
Suppose you bought EURUSD at a price of 1.2000. However, you do not want to lose more than 10% on this trade if you falls in the price instead of going up. Then, immediately after the EURUSD purchase, you place a stop-loss order at a price of 1.1950. This sell order will not be executed by your broker the time being. Only when the price of the EURUSD drops to 1.1950 or below, then the stop loss order will be executed.
Why is a stop-loss order so important ?
It prevents you from losing a large part of your capital, as it does to many retail traders, for example. Unfortunately, it is typical for a retail forex trader to buy currency and then only after many days to look back at the price and realizing that your account is in RED figures meaning you have big problem.
Instead, a stop-loss order should minimize losses and secure profits!
Even if nobody likes to realize losses:
it is still better, e.g. Make a 10% loss on one trade and then sell it on time THAN being depressed and watching your open forex contract as it loses more and more, until half or even more of the capital originally invested has been destroyed!
How to set a stop-loss order?
Of course, that’s not great art. You simply give your forex broker a sell order for your shares with the order suffix “Stop Loss” and the desired stop-loss level. Nowadays all retail forex brokers accept such orders and you can place it with one click on your forex platform via the Internet. Usually you don’t pay anything for placing a stop-loss.
At which price level should you now set your stop-loss order?
There are different ways:
Defining a maximum loss
Say you have bought EURUSD contract and invested $2000 for this trade since you anticipate the EUR will get stronger than USD. You know that you will need $1700 dollars capital in the future, e.g. to purchase bitcoin. Then you should set a stop-loss order to at a price level that will allow you to loose in the worst case only $300 and then it will be stopped. Of course if the EURUSD goes up as you anticipated, nothing will happen and you reap profits.
Of course, as explained in the introduction, you can also define a percentage loss that you would like to suffer at the most. Make it clear once again: it is better to realize 10% loss than to watch how half of the capital is destroyed.
If you e.g.
Buy EURUSD for 1.2000 per share and do not want to suffer more than 10% loss, so set a stop-loss sales order at 1.2000 * 0.9
So easy and powerful, but you need to learn where exactly to place stop loss. It always depends on many factors, where main is your risk appetite of course.
Set a stop-loss level by chart analysis
Of course, the most professional thing is to look at the currency pair charts and determine which price level should not be undercut. Of course, chart analysis is a science of its own with which a retail investor does not necessarily want to deal. But a very simple method would be, for example, to look at where the price has formed a clear low the last time in his up and down movements.
While each currency pair price will fluctuate between highs and lows even when the pair moves higher, in an intact uptrend, however, the following low should be higher than the previous one; a once trained low should not be undercut. If this happens anyway, it may indicate an end to the uptrend and the onset of a downtrend so it is best to sell for safety and watch the prices continue to move forward. If you want to do that, you could put your stop-loss order just below the last significant low of the currency pair.
However, it is important:
No matter where you set your stop-loss order, you should always follow the level of the stop-loss price at regular intervals !!!
You should also learn:
- What is PIP and how to calculate pip value
- What is LOT
- What is SPREAD