This article looks at the different ways to place a stop loss order on the foreign exchange rate market.
The stop loss order is used as a safety mechanism when trading on the foreign exchange rate market. The order is set to exit a trade if the trade turns bad and begins to show a loss. Some traders feel that stop losses are unnecessary and often forget to set them, however these traders often find themselves victims of detrimental losses. It is imperative that you use implement a stop in every trade regardless of third party advice. While these orders can be used as traditional exits and emergency exits, the article will examine placing a stop as a traditional exit.
Placing a stop loss order correctly
There are two different methods to placing a stop loss order – the discretionary trading method and the system trading method. The method used to place stops is based on your trading style; therefore it is important you are sure of your trading type before considering the stop loss order.
1. The discretionary trading method
The discretionary trading method is used when placing a stop loss order at a price which you do not expect the market to trade at. The idea behind this method is that if the market is to reach that stop loss price you will not longer want to be in the trade, thus the stop will be a guaranteed exit from the trade.
2. The system trading method
The system trading method is seen when placing a stop loss order based on your trading system’s risk/reward and win/loss rations. This method is based on mathematical calculations with no emotional discretion on where it should be placed. For example, if the trading system indicates that the most effective stop loss position is 10 ticks behind the entry point then the stop will be placed there.
There is a second form of the system trading method that utilising indicators as a basis for stop order placement. If you feel that a particular indicator shows an effective trade exit, then you have the option of placing a stop loss order at this point. Either form of the system trading method is suitable as both are based in technical analysis.
Placing a foreign exchange rate stop loss order incorrectly
There are numerous ways in which a stop loss order can be incorrectly placed. The most common ones include the percentage based stop loss and the random price stop loss.
1. The percentage based stop loss order
Percentage based stop loss orders are seen when the order is placed at a fixed percentage behind the entry price. These percentages are generally based on the entry price or value of the trade and not market movement. Due to this type of measurement they are ineffective stop loss placements.
2. The random price stop loss order
The random price stop loss order is an order placed at any price on the market, chosen completely by chance. As with percentage stops, the random price stop is not based on market movement and cannot be tested. This means there is no way of testing the reliability and effectiveness of this type of stop loss order.
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