What is a stop-loss, how to correctly calculate and set it

One of the first rules of trading on the currency market, which is insistently put into the trader's head, is the mandatory setting of a stop-loss order to limit your possible loss, if the price goes in the opposite direction to the open deal. There is no doubt that one of the most important qualities of a trader is the ability to manage his losses - this is the direct purpose of the StopLoss order.

StopLoss is ...

Stop Loss is A type of stop order (order) placed by a trader in order to limit possible losses in a situation where the market has gone against the open trade.

What is a stop loss

What is StopLoss for?

A StopLoss order is a necessary element of the rules capital management on the and allows, in the case of a price reversal against the transaction, to close a losing position with a planned loss, giving the trader the opportunity to manage their trading risks.

In today's turbulent markets, trading without a stop loss is simply unthinkable. When one of our colleagues loudly declares that he never uses stop-losses (supposedly a combination of different exits gives him a significant advantage and allows him to work without stop-loss orders), professionals understand 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.

Trading without stop-loss orders is more common among amateurs. For professionals, the main priority in trading is to protect trading capital from ruin - everything else (the amount of profits or losses) is secondary.

How does the stop loss work?

Stop-loss automatically closes the placed position when the set price value is reached. The order is stored on the server of the broker's company, so there is no need to keep the terminal turned on to trigger it.

StopLoss order can close a deal either for the whole volume at once or for 1 contract (lot). The opposite order, the main purpose of which is to fix the profit from the transaction, is the following Take Profit.

Stop-loss can be set for any type of order, including deferred.

How to set a StopLoss order in MetaTrader 4?

To set a stop loss order in the MetaTrader 4 terminal when opening a position, you must enter the necessary price value for triggering an order in the Order panel.

What is a stop loss
Setting a Stop Loss Order in MetaTrader 4

For an open trade, the StopLoss order value can be changed via the "Modify/Delete Order" tab.

Stop-loss for a buy trade is set below the position, for sell - above the position.

Technical rules for setting a stop loss

From a technical point of view, placing a stop loss order depends on strong support and resistance levels. For trend trading these levels are trend lines, for trading in Flat - his boundaries.

How to set stop-loss and take-profit correctly
Stop Loss and Take Profit Trading by Trend

The logic is simple. The price is unlikely to break through a strong support or resistance level and there is a high probability of a bounce from it. Therefore a stop-loss is placed behind such level, as a rule, at the level of the previous maximum (minimum). If the support (resistance) level is broken, then the continuation of the trend, in the calculation of which we opened the trade, of course, is out of the question.

How to set stop-loss and take-profit correctly
Stop Loss and Take Profit at Flat Trading

The same principle of placing stop-loss orders is used in all types of trading. Strong support and resistance levels can be determined independently (previous local minimums and maximums) or by using technical indicators of levels.

There are several important things to consider when setting a stop loss;

  • First of all, you need to understand that stop-losses behind important levels are set by many market participants. The older the timeframe, the stronger the level, and the greater the probability of accumulation of other traders' stop-losses near it, which, naturally, increases the probability of your order triggering.
  • You should not place a stop loss at "round" levels - 100, 750, and so on. For some reason, these levels psychologically attract most traders.

Rules for calculating stop-loss

Having determined the technical rules of setting stop-loss orders, we can proceed to the calculation component, remembering rules of maneuveringIt is strongly advised not to forget them.

Essentially, the size of the stop-loss is a reflection of the amount the trader is willing to risk in an open trade. Entering the market, as traders say, "for the whole cut," the risk, of course, is 100%. Ideally, the recommended risk level should be 2-5% of the deposit for each trade.

For example, the trader's deposit is 5000 dollars. The trader has set for himself the maximum amount of risk 5%. Accordingly, the loss on the transaction should not exceed 5000 x 0.05 = $250.

Next, we should evaluate the relationship between the size of the stop-loss, the price of one point and the volume of the position. The trader has calculated that when opening a position at a given point, the stop-loss will be located 50 points from the entry point. The value of one point will be $250:50 = $5. Given that the position size of 1 standard lot, the price of 1 pip is $10, we obtain the recommended position volume of 0.5 lots.

The above example is optimal and does not take into account such a psychological factor as greed. Unfortunately, many traders, in the pursuit of profit, trade the whole lot at a deposit of $ 1000. Consequently, there is no risk management and calculations whatsoever.

When placing stop-loss and take-profit orders, remember one more very important detail. spread.

For example, we opened a long position in the EUR/USD pair with a stop loss of 1.1150 and take profit of 1.1230. The spread is 2 pips. Correspondingly, a Take Profit is triggered when the price reaches 1.1232, and a Stop Loss is triggered when the price reaches 1.1152.

This example is for a fixed spread. For accounts with floating spreads, things are a bit more complicated, because during the release of important economic data or fundamental events, the size of the floating spread can increase several times.

To learn more about how to correctly calculate a stop-loss order, watch the webinar of the famous trader Alexander Gerchik:

What is Breakeven?

Breakeven (Breakeven level, BL) - Transferring a StopLoss order in an open trade to the level of the opening price, after the price has passed in the desired direction a certain number of points.

How do I make a deal Breakeven?

To limit potential losses when opening a position, the trader puts StopLoss order. If the situation on a currency pair is assessed and analyzed correctly and after opening a position the price moves in the right direction, the trader can avoid losses in case of a price reversal in the opposite direction. To do this, the stop-loss order is moved to the level of transaction opening.

What is breakeven
Example of an open transaction

In order to move the stop-loss on the level of opening of the trade or, as traders say, to move the trade to Breakeven, in the MetaTrader 4 terminal it is necessary to modify the stop-loss order by setting the value of the opening price of the position in the corresponding field.

What is breakeven
Transferring a trade to Breakeven

If the price, not reaching the take profit level, for some reason turns around, the position will be closed at the opening price, or closed at breakeven, saving the trader from losing money.

What is breakeven
Transaction placed at breakeven

How to correctly set the Breakeven level?

Often traders, especially beginners, rush to breakeven as soon as the price passes the minimum number of points from the opening level. As a consequence, in case of price fluctuations the deal is closed at Breakeven, after which the price continues to move in the right direction. As a result, a potentially profitable trade is closed without a loss, but without profit, and especially reckless traders hurry to reopen the position, but at a less favorable price, thereby increasing their trading risks.

There are no exact instructions on when to move the stop loss to the breakeven level. It depends on the volatility of the currency pair being traded, the time frame being used and the type of trading. As a rule, each trader selects these levels independently, experimentally, using Fibonacci levels, fractals, Pivot levels or any other technical tool.

How to make breakeven profitable?

If the trade is set to breakeven, even the triggering of a stop-loss order can bring profit. For this purpose, in case of further price movement in the right direction, the stop-loss order is also moved in the same direction. Thus, if the price reverses in the opposite direction, the transaction is closed by the stop loss, but at the same time the trader receives some profit.

What is breakeven
Moving a stop-loss order from the breakeven level to the profit zone

In the example on the picture, in case of price reversal and closing the position at stop-loss, the trader will receive 1.13291 (opening price) - 1.13112 (level of transferred stop-loss) = 179 pips profit.

Trader can transfer a stop-loss order either manually or using the built-in terminal function trailing stop.

What is a Trailing Stop Loss or Trailing Stop

As a rule, trailing stop is used in trend strategies when it is necessary to preserve the existing profit, although it can be used in any trading tactics.

For example, after the price rebounds from the support line of an uptrend, you open a long position, setting Take Profit at the resistance line, and the stop loss - below the local minimum. As you know, the market is fickle. Suppose, due to some factors, the price did not reach your take profit order. The next time you look at the trade, instead of the expected profit, at best you will have time to fix the rest of it, at worst you will get a loss on the stop loss.

Figure 1. Example of a price reversal, not reaching a take profit order.
Example of a price reversal, not reaching a take profit order.

How to avoid it? This is what a trailing stop is for.

Trailing Stop (Trailing Stop, "floating stop") - is an algorithm of Stop Loss order management without active participation of the trader. Trailing stop allows the level of stop-loss to move behind the price, in case of its movement in the right direction.

How to set a trailing stop on Forex?

Simply put, a trailing stop on Forex drags with it a stop-loss order on the number of points specified by the trader, for which the trader's slang is called a "trawl". For example, at the level of 1.24643 there is a Sell trade on EUR/USD with Take Profit 1.24530 and Stop Loss 1.24709.

In order to set a trailing stop in trading terminal MetaTrader 4The context menu must be called by right-clicking on the transaction line.

Fig. 2. Calling the context menu to set the trailing stop.
Call the context menu to set a trailing stop.

In the menu you can choose the suggested number of points or set it yourself. After setting the trailing stop, the value of stop loss in the line of the trade will be highlighted in yellow. It means that the trailing stop is activated.

Fig. 3. Activated trailing stop.
Activated trailing stop.

IMPORTANT: When setting a trailing stop, pay special attention to the fact that the value of "pip" for a five-digit quote is not equal to a standard pip, but represents the minimum value of price change. That is, the value of "50 pips" in the terminal with four-digit quotes and "50 pips" in the terminal with five-digit quotes will differ by a factor of 10 (5 pips in four-digit quotes = 50 pips in five-digit quotes).

Once the price moves in the direction we want and reaches 1.24593, the trailing stop will automatically move the stop loss to Breakeven at 1.24643 and if the price declines further, it will move the stop loss 50 pips away from the price. You can see on the screenshot that when the price reached 1.24582, the trailing stop loss moved to 1.24582 + 50 pips = 1.24632.

Fig. 4. Transferring a trailing stop to a stop loss order.
Transferring a trailing stop to a stop loss order.

It is worth immediately noting that the trailing stop moves the stop loss only when it moves in the right direction. That is, when the price moves in the direction opposite to the open trade, the stop-loss will not move away from it.

The screenshot below shows that after moving the stop-loss to the level of 1.24632, the price corrected by up, but the stop loss remained in place and began to move only after the price resumed its decline and the distance between it and the stop loss again exceeded the set 50 pips.

You can delete trailing stop through the same context menu. If you click on "Delete All Levels", the trailing stop will be canceled for all open orders on which it was set, if you click on "No", the trailing stop will be removed from the selected order.

Fig. 5. Price correction and resumption of trailing stop.
Price correction and resumption of trailing stop.

Nuances when using a trailing stop

Trailing Stop will begin to move the stop loss only after the price passes the number of points you set. Until then the terminal will not take any action.

When using a trailing stop, you do not need to place a stop loss order; the trailing stop will place a stop loss itself at the level of the deal opening once the price has passed in the desired direction the specified number of points. However, the experts of ForTrader.org magazine recommend putting a stop-loss order when opening a deal, because no one is insured against force majeure and the price can change without passing the required distance for triggering a trailing stop.

As mentioned above, a feature of the trailing stop is that the stop-loss moves behind the price only when it moves in the right direction. In other words, simply put, the trailing stop pulls the stop loss, but never moves it away from itself.

The next feature is the binding of the trailing stop to the trading terminal. That is, the trailing stop function will only be active when the terminal is on. If you close the terminal, your stop-loss will not move anywhere.

There is always a minimum distance from the current price at which a trailing stop can be set. It may vary from broker to broker. In the example above, it was 50 pips. For a beginner it is especially important to correctly calculate the trailing stop level. If it is too high, you will receive minimal profit if the price turns, or the trailing stop will simply not move the stop loss to the open order level. If the trailing stop level is too small, there is a high probability that the order will be closed at the slightest price noise.

Useful articles on the topic

Leave a Reply

Back to top button