Making profits in forex trading is rewarding, but it also comes with several challenges and risks. However, several tools and indicators help to limit and control risks. In forex trading, one of the most popular and successful trading strategies is stop-loss orders. When it comes to risk management, stop-loss orders play a critical role, which is why it is crucial to understand what they are and what they do before you start trading.
What is a Stop-Loss Order?
A stop-loss in forex trading is an order a trader makes with an agent or broker in an attempt to quit the transaction after achieving or reaching a specific price in the money market. Moreover, it is a requirement when trading in the foreign exchange market since it helps to keep a trader’s capital losses to a minimum in a single transaction.
Some traders, especially those that use their emotions when trading, choose not to utilize the stop-loss order it is not part of their initial trading plan. A stop-loss order not only safeguards your trade from a significant financial loss but also removes the emotional element that may lead you to overtrade and incur losses that are even more considerable.
Types of Stop-Loss Orders
Stop-loss orders come in a variety of forms, each with its own set of advantages and disadvantages. The type of stop-loss order a trader chooses primarily depends on the technical, fundamental, or trading analysis techniques used. Below are the most common stop-loss orders.
1. Volatility Stop
A Volatility stop is one of the most potent technical analysis tools used in a stop-loss order. Just as the name implies, it bases its activities on the historical and present-day volatility of the currency pair you intend to trade. During a downtrend, the indicator displays red dots above the price bars, and in the case of an uptrend, it shows green dots underneath.
It is possible to utilize these levels as trailing stops and overlays for timing trading departures from open positions. You can also use the same to identify uptrends and downtrends since price passing the depicted level might signal a reversal in the direction of the trend. Suppose you want more accuracy to calculate the volatility stop. In that case, it is advisable to use it with the Average True Range indicator, which many traders use in conjunction with other indicator tools and analytical methods.
2. Chart Stop
Using chart stops is one of the most popular and successful stop-loss orders. Technical analysts and the more experienced traders prefer it to other strategies because they easily deduce the exit position by using support and resistance levels. Other significant technical levels used by chart stops are trendlines, chart patterns, moving averages, and channels.
When using chart stops, it is customary to set your stop level slightly below or above the technical levels, assuming that if there is a breach, the present price course will change, rendering the trade worthless.
3. Percentage Stop
A percentage stop is another kind of stop-loss order calculated based on the percentage of a trading account utilized to place the order. Unlike chart stops, percentage stops are set at a level that, if achieved, limits losses to a percentage of the entire value of the trading account rather than following technical levels of importance.
4. Time Stop
A time-stop is a stop-loss order mainly dependent on the passage of time. This type of strategy is particularly popular with day traders that do not wish to keep their positions open after trading bells ring for the close of the day trading.
It is also popular with traders that want to terminate their trading before the end of the trading week. For best results, it is advisable to use time stops with other stop-loss strategies.
Suppose you do not want to risk additional losses when trading. In that case, it is always advisable to make a stop-loss order significantly if your investments drop down to a particular level. One of the many mistakes inexperienced forex traders make is underestimating or downplaying the risks involved in trading, which makes them collect losses day after day.
If you are a novice trader and everything you try to do goes wrong, every strategy you use plays against you; minimize the losses by using one of the most straightforward tools in the forex trading market- a stop-loss order.