Forex Trading And Setting Stop Losses

The use of stop losses is an incredibly volatile topic among traders. Some say use them. Some say don't. Some say the brokers hunt stops. Some say that is foolishness. Some say keep them close. Some say put them several levels deep. What do I say? (After all, this is my blog!)

There are two sides to every coin. So I say let's examine the pros and cons of each side and see what we can figure out.

The truth is...both are right. It simply depends on your own trading style.

I have traded without stops before. And before I knew how to do it, it cost me a bundle. Trading without stops means you have to scale your position down to the nearly lowest possible point. For instance, if you have a $5000 account, you should probably stick with 10 cent pips. Then even a 1000 pip move against you is still only taking $100 of your total account. Using smaller pip increments can allow you to build tremendous positions as the price moves against you So if you added a position every time the price moved 100 pips against you, you would end up with 10 positions, and each pip would now be worth $1.00. Your draw down would be $550 on a $5000 account. That is more than many traders would recommend, but you're not trading like most traders. And you can be assured not many currencies travel 1000 pips without a retracement. At this point you only need a retracement of 550 pips to break even. If the currency moved even to its first fibonnacci retracement area, it would fall about 490 pips, and the likely hood that it would stop there would be pretty low. But what you're looking for in this instance is not just a retracement, but a change in direction. Moving to its previous low would net you $450, and any move beyond that would be even more.

Also please note, those kinds of movements usually take months to play out. So even though you're looking at a nice return of 10%, it may take 8 to 12 weeks for such a move to come to completion.

Thus, the key to NOT using stops is gearing down your leverage to the very lowest of levels.

If you are not willing to trade like that, then you must use stops. I think I said once that a man would be a fool not to do so. Other wise, if your leverage is geared up and you have no stop, you will blow out your account in a relatively short matter of time.

So, moving ahead on the assumption that we are using stops, what is the best way to go? Close to my entry or farther away?

Again, it depends on your trading style. Some traders are short termers, and others are longer. When I talk about a short termer, I'm talking about someone who trades on the 15 minute charts or less. If that is your trading arena, you should keep your losses shorter, and closer to your entry. The reason why is this. Short term signals are notoriously less reliable. So you don't want to base a big loss on a faulty signal. Also, short termers should look for smaller profits. It is true that every 200 pip move starts with a signal on the five minute chart at the very beginning. But it is a serious mistake to look for that on every trade. If you're trading 0n 5 or 15 minute charts, be happy with with 10-30 pips. On that short term of a trade, I will move my stop to break even after I profit just 10 pips. But that also means that I have to be shorting near a good swing high or buying near a good swing low. If I am not close, my stop will be too wide to have a good reward risk/ratio. In other words if I am looking for just a 20 or 30 pip profit, I can't be having a 20 or 30 pip stop loss. 5 to 10 would be maximum plus I have to add in the spread. My stop should be less than than my profit target at all times.

So let's wrap this up here, and continue tomorrow.

Happy Trading!

Bill