Trading Nouances: Techniques for Placing Stop Loss Orders

The correct choice and technique of setting the StopLoss level allows you to optimize dealing in the financial markets. The StopLoss order elegantly provides one of the simplest and at the same time most important exits from the market. В previous article we have seen the importance of a quality market exit. Such an exit prevents the trader's ruin by protecting the trading capital.

Why is it important to put a StopLoss?

In today's turbulent markets, trading without a stop loss is unthinkable. When one of our colleagues at scientific seminars loudly proclaims that he never uses a stoploss, it is unthinkable. StopLoss orders (allegedly the combination of different outputs provides him with a significant advantage and allows him to work without StopLoss orders), then professionals realize that his ruin is only a matter of time.

The inevitability of such an outcome is foreshadowed by the past years, when an unprotected position inevitably runs into a strong price drawdown or outflow in the opposite direction from the trade, measured in tens of figures. In this case, the strongest deposit can turn into "dust" with a sum of zero in the account.

Aversion to StopLoss Orders is more common among amateurs. For professionals in trading, the main priority is to protect the trading capital from ruin - everything else (the amount of profits or losses) is secondary.

And this is understandable, since this business (currency dealing) requires trading capital - a deposit on a trader's account. Without it there will be no business. With the execution of a StopLoss order, you incur tactical losses, but the business is protected and you have a chance to recover and even increase your deposit.

Note that in this context we do not claim that our objective is to eliminate or reduce the risk of losses in the trading process. Losses are an integral part of dealing. Successful traders often have more losing trades than amateurs. However, it is all about the size of possible losses. Losses that are significant to your deposit must be eliminated at all costs, and such losses are easily eliminated by the steady execution of a simple StopLoss.

Amateurs often mistakenly believe that they are such good traders - professionals - that they can avoid using stops. However, the statistics are that amateurs fail quite quickly in dealing regardless of whether they use a StopLoss order or not, while the prosperous trader trades and makes money. The longer and better your trading process goes, the more chances you have to "run into" a strong price time series discord.

StopLoss Order sets the level of possible losses that a player is ready to accept and get out of a losing deal without unnecessary grief. The presence of the level of loss limitation largely reduces the psychological pressure associated with being in a losing position.

This fact also helps a trader before entering a trade. Suppose a trading system suggests us to enter a certain market tomorrow, and we have an unknown and unlimited possibility of losses. No reasonable trader would want to enter such a trade. The predetermined level of the StopLoss order will tell us what can happen in the most negative scenario of market dynamics. And this makes it psychologically easier to accept trading signals for action and enter the market.

Of course, no sensible trader would ever open a position that is sure to bring him a loss. But it is necessary to hedge against undesirable market events. We thereby prepare ourselves for a negative scenario and determine what losses are acceptable for us. This knowledge gives us confidence when entering a trade and psychologically prepares us to accept losses, which can never be excluded. Of course, StopLoss does not always accurately determine the size of losses in the worst case scenario, because the market sometimes opens with slippage.

Stop Loss Techniques

The most common stop order is to lock in a loss after a fixed price change from the trade entry level. This stop option is easy to use and is found in most trading programs, allowing you to incorporate it into your trading system. It is important to note here that the wrong way to place a stop is to first roughly estimate the marginal amount of money you can lose on a single trade and then place a stop order according to the resulting number. However, the market does not commensurate its price dynamics against your position with how much capital you are willing to lose.

Correct placement of StopLoss is to use important support and resistance levels. For example, a fixed StopLoss should not be placed too close to the market, as random market fluctuations may cause early exit from the trade. At the same time, a StopOrder should not be placed too far from the market, because then the size of the loss may be larger than necessary. Our experience shows that a fixed stop/loss should be placed based on the study of the volatility market. For example, if the average daily trading range of the market is $1500, it is recommended to place a fixed stop/loss at least at $1500, if not further. This stop size should keep the open position from random price fluctuations, while at the same time fulfilling its capital saving function.

It is important to understand the volatility characteristics of the market you are trading and not to blindly use a fixed Stop Loss order if the market has changing volatility characteristics. In such a case, it is more appropriate to develop a stop/loss order that is adaptive to such likely changes, depending on the current market volatility.