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In the world of trading, while many are fixated on the profits made, experienced traders know well how protecting the downside or capping losses is crucial.
The reason is because the market is filled with volatility and therefore it becomes important to have some risk-management mechanism in place.
One such widely-used mechanism for reducing risk exposure is the stop loss.
Let’s explore how to effectively implement stop loss strategies not just in Forex, but across stocks, commodities, and cryptocurrencies, to ensure maintaining robust control over our investments in any market condition.
What’s a Stop Loss?
Simply put, a stop loss order is an automated risk-management instruction set by traders with their brokers to sell a specific security once the price of it reaches a pre-specified level.
This principle applies not just in Forex, but also in trading stocks, cryptocurrencies, and commodities, each of which has its own set of volatility and risk factors.
Let’s say you’re trading a stock XYZ, which you bought at $100, and you don’t want to hold it if the price falls below $90.
This is the level where you will place your stop loss to protect the trade from incurring further losses.
Similarly, in the commodities market, if you’re trading gold, you might set a stop loss order to sell if the price falls 10% below your purchase price to minimize losses in a volatile market. In the cryptocurrency space, where price swings can be more drastic, setting a stop loss order can protect against sudden downturns in a coin’s value.
While stop losses can help you target the trades you want to make, many traders follow them the wrong way.
They find prices of a security spiking up to highs and lows to find stops and then proceed in the reverse direction they wanted to trade. That not only leaves them with losses but also limits the profit potential. This is a typical example of something called ‘stop hunting’.
So, let’s talk about how one can effectively determine stop loss levels and avoid falling victim to ‘stop hunting’…
Avoid Stops at Support and Resistance Levels
One simple way to set a proper stop loss so you don’t get stopped out too early is to avoid placing your stops just below the support or above the resistance levels of an asset.
Why?
Because that’s where most traders place their stop loss. Plus, it also incentivizes the big institutional traders to push the price to those levels as it likely offers them better entry and exit points on their trades.
This principle holds true across all trading disciplines. For example, in forex trading, avoiding stops right at common support or resistance levels can prevent being ousted by normal price fluctuations that test these barriers.
Here’s how you can tackle this situation instead…
Stop Loss with Price Confirmation and Alerts
Let’s say you are trading the EURNZD currency pair and planning to buy it at the 1.6800 levels.
The below chart shows you there are two stops you can place for this trade which are the recent lows for EURNZD. These are placed at around 1.65 levels and at 1.63 levels as shown in the image below.
Buy Trade on EURNZD
So, the setup for this trade is to close the trade in case it falls to these stops. However, what we would do is stay put in the trade as long as the price doesn’t close below these above mentioned stops.
What we are essentially doing here is waiting for the price to confirm if it’s going to fall further or if it will bounce back towards our target levels.
A simple hack to keep track of this is to place a trade alert at stop levels. This will let you know when the price touches the stop.
So, for the EURNZD trade, we can set an alarm at the stop of 1.65 levels. Once the price touches it and we’re alerted, we wait to confirm if it is closing below 1.65. If the price does close below, we can exit the trade.
However, if the price has touched 1.65 levels but doesn’t close below it, we believe the best approach is to stay in the trade as chances are that it might bounce back towards our target.
Similarly, for commodities like oil, where volatility can be influenced by geopolitical events or changes in supply, setting alerts for prices nearing your stop loss level can give you a chance to reevaluate the position before closing.
In cryptocurrency trading, given the rapid price changes, using alerts in combination with technical indicators like relative strength index (RSI) or moving average convergence divergence (MACD) can provide a more informed decision when stop levels are hit.
Now, the same strategy applies to stops placed above resistance levels where you’re looking to sell a security.
Say if your trade on EURNZD was successful and you made profits by closing your Buy trade at high levels. What you can do next is to have a Sell trade on the currency pair.
Let’s say the pair is trading at the high of 1.75 levels and we’re now looking to sell it in anticipation that the price will make a U-turn and fall from recent highs.
In this case, our stop will be placed at the recent high which is the resistance level of 1.75, as seen in the image below.
Sell Trade On EURNZD
For this trade, we will set an alert at a stop of 1.75 levels. Once the price touches the stop level and we’re alerted, we wait to confirm if it is closing above 1.75. If the price closes above it, we can exit the trade.
On the other hand, if the price doesn’t close above our stop, the best approach is to stay in the trade as chances are that it might fall back towards our target levels.
Conclusion
Effective stop loss strategies are more than just safety nets—they are critical tools that empower traders to navigate through market volatility with confidence.
To quickly wrap it up, here are the three points to consider while trading with stop loss orders:
- Set your stop loss at a distance away from the support or resistance level.
- If you’re in a Buy trade, do not close the trade (or let the stop loss trigger) as long as the price doesn’t close below the support level.
- If you’re in a Sell trade, do not close the trade as long as the price doesn’t close above the resistance level.
This strategy can help ensure not closing a trade too early unless the price confirms a strong price rejection. That way, one can avoid unwanted losses and let trades run for higher potential profits.
In conclusion, knowing the difference where you trigger your stop losses can go a long way in having a sound and potentially rewarding market strategy.
In fact, we’ll go on to say that it’s one of the risk management techniques that can separate successful traders from average traders.
By applying these stop loss principles across various markets such as stocks, commodities, and cryptos, you can create a more robust trading strategy that takes into account the unique characteristics of each market.
And this holistic approach to stop loss strategy not only enhances your risk management but also diversifies your trading tactics across different asset classes, providing you with a more resilient trading portfolio.
Our top analysts are reading a few trade setups with these stop loss strategies on their current trades. Their charts are showing an exciting pattern which they plan to trade for BIG potential gains. Know about these trades and follow them LIVE by clicking HERE.
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