Market movements can be unpredictable and the stop is one of the few mannerisms that traders have to prevent one single trade from ruining their careers. When traders begin to learn to trade, one of the primary goals is often to find the best possible trading system for entering positions. After all, if the trading system is good enough, all the other factors like risk management, or trade management — well, they can take care of themselves, right?
After all, if our trades are moving in our direction and we are making money, all of these other factors might seem unimportant: All we have to do is find that system that works at least the majority of the time, and then most traders figure they can figure everything else out as they go along.
Unfortunately, the truth is that all of the above assumptions are hogwash. There is no system that will always win a majority of the time, and without trade, risk, and money management — most new traders will be unable to reach their goals until they make some radical changes to their approach.
This is a wall that many traders will hit, and a realization that will become part of most of their realities. Because likely, none of us will ever walk on water, or have a crystal ball so that we can display super-human capabilities of predicting trend directions in the Forex market.
Instead, we have to practice risk management ; so that when we are wrong, losses can be mitigated. And when we are right, profits can be maximized. Once again, most traders that will find success in this business are going to come to this realization before they can adequately address their goals. Realizing that risk management must be practiced is one thing, but doing it is an entire different matter. Stops are critical for a multitude of reasons but it can really be boiled down to one simplistic cause: You will never be able to tell the future.
Regardless of how strong the setup might be, or how much information might be pointing in the same direction — future prices are unknown to the market, and each trade is a risk. In the DailyFX Traits of Successful Traders research, this was a key finding — and we saw that traders actually do win in many currency pairs the majority of the time.
The chart below will show some of the more common pairings: So traders were successfully winning more than half the time in most of the common pairings, but their money management was often SO BAD that they were still losing money on balance.
In many cases, taking 2 times the loss on their losing positions than the amount they gain on winning positions.
This type of money management can be damaging to traders: The chart below will highlight the average loss in red and the average gain in blue. Traders lost much more when they were wrong in red than they made when they were right blue.
So if a trader opens a position with a 50 pip stop, look for — as a minimum — a 50 pip profit target. This way, if a trader wins more than half the time, they stand a good chance at being profitable.
But now that we know that stops are critical, how can traders go about setting them? Traders can set stops at a static price with the anticipation of allocating the stop-loss, and not moving or changing the stop until the trade either hits the stop or limit price. The ease of this stop mechanism is its simplicity, and the ability for traders to ensure that they are looking for a minimum 1-to-1 risk-to-reward ratio.
This trader wants to give their trades enough room to work, without giving up too much equity in the event that they are wrong, so they set a static stop of 50 pips on every position that they trigger. They want to set a profit target at least as large as the stop distance, so every limit order is set for a minimum of 50 pips.
If the trader wanted to set a 1-to-2 risk-to-reward ratio on every entry, they can simply set a static stop at 50 pips, and a static limit at pips for every trade that they initiate. Some traders take static stops a step further, and they base the static stop distance on an indicator such as Average True Range.
The primary benefit behind this is that traders are using actual market information to assist in setting that stop. So, if a trader is setting a static 50 pip stop with a static pip limit as in the previous example — what does that 50 pip stop mean in a volatile market, and what does that 50 pip stop mean in a quiet market?
If the market is quiet, 50 pips can be a large move and if the market is volatile, those same 50 pips can be looked at as a small move. Using an indicator like average true range, or pivot points, or price swings can allow traders to use recent market information in an effort to more accurately analyze their risk management options. Average True Range can assist traders in setting stop using recent market information.
If the trade moves up to 1. This does a few things for the trader: This break-even stop allows them to remove their initial risk in the trade, and now they can look to place that risk in another trade opportunity, or simply keep that risk amount off the table and enjoy a protected position in their long EURUSD trade.
Break-even stops can assist traders in removing their initial risk from the trade. Well, in this case, they can remove the limit altogether and instead look to trail their stop as the trade moves higher. After price moves to 1. Traders can look to manage positions by trailing stops to further lock in gains. This is maximizing a winning position, while the trader is doing their best to mitigate the downside. There are multiple ways of trailing stops, and the most simplistic is the dynamic trailing stop.
With the dynamic trailing stop, the stop will be adjusted for every. Dynamic Trailing Stops adjust for every. Traders can also set trailing stops through Trading Station so that the stop will adjust incrementally. For example, traders can set stops to adjust for every 10 pip movement in their favor.
If the trade reverses from that point, the trader is stopped out at 1. For traders that want the upmost of control, stops can be moved manually by the trader as the position moves in their favor. This is a personal favorite of mine, as price action is a heavy allocation of my approach, and many of my strategies focus on trends or fast moving markets. When using price action, traders can focus on the swings made by prices as trends move higher or lower.
During up-trends, as prices are making higher-highs, and higher-lows — traders can move their stops higher for long positions as these higher-lows are printed. Is it Always a Bad Thing? DailyFX provides forex news and technical analysis on the trends that influence the global currency markets. Click here to dismiss. How to Set Stops.
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