A stop loss is a tool which allows you to protect your trades from unexpected market movements by letting you set a predefined price at which your trade will automatically close. Therefore, if you enter a position in the market in the hope the asset will increase in value, and it actually decreases, when the asset hits your stop loss price, the trade will close in order to prevent further losses.
It is important to note, however, that stop losses are not a guarantee. There are occasions where the market behaves erratically and presents price gaps. If this happens, the stop loss will not be executed at the predetermined level but will be activated the next time the price reaches this level. This phenomenon is called slippage.
A good rule of thumb is to set your stop loss at a level that means you will lose no more than 2% of your trading balance for any given trade.
Once you have set your stop loss, you should never increase the loss margin. There’s no point having a safety net in place if you aren’t going to use it properly.
There are different types of stops in Forex. How you place your stop loss will depend on your personality and experience. Common types of stops include:
- Equity stop
- Volatility stop
- Chart stop (technical analysis)
- Margin stop
If you find you are always losing with a stop-loss, analyse your stops and see how many of them were actually useful. It might simply be time to adjust your levels to get better trading results.
In addition, a protective stop can help you lock in profits before the market turns. For example, once you have opened a position and have a floating profit of $500, you can move your stop loss closer to the current price, so that if it was hit, your trade would close with some of your profit still in tact. If the trade keeps going your way, you can continue trailing the stop after the price. One automated way to do this is with trailing stops.