Stop-loss trading orders are one of the most important parts of every forex trader’s strategy. Naturally, there are traders who are brave enough to trade without stop-loss orders or other kinds of capital protection, but it can be very hard for them to achieve stable results long-term.
Stop-Loss orders created irrespective of the entry point are often placed:
To make the difference between the four approaches to placing stop-loss orders clearer, let’s look at all of them in detail on one chart with the same amount of space for a potential market entry.
1) Stop-loss order under / above the candlestick preceding the candlestick that gave you a signal to enter the trade:
On the chart, you can see the entry (long in this case) candlestick, which is preceded by another long candlestick with a long lower shadow.
A stop-loss order placed this way is usually relatively small but also adjusted according to the current volatility and situation on the market.
2) Stop-loss order under / above the closest previous market swing:
Here, you can once again see the same entry candlestick, but the stop-loss order is placed at the level of the previous swing. Such stop-loss orders are usually placed a couple of pips under the swing and the highest possible placement of the stop-loss order should be at the LOW level of the swing (be careful, it is very likely that the price will reach the swing point again and the market will bounce off it, and that is why it’s more beneficial to place the stop-loss order a few pips below it).
This type of stop-loss placement is mostly employed by short-term intraday or medium-term swing traders.
3) Stop-loss order based on a calculation (the potential risk-reward ratio):
On the chart above, a possible entry point (long) is marked green, then there are two horizontal lines. The lower line represents, for the purposes of this example, a model stop-loss order and the upper line is the profit-target order. The potential risk-reward ratio is set at 1:3, and that is why the stop-loss order is placed 500 points under the entry point and the profit-target order 1500 points above it.
This method of placing stop-loss orders is universal, and that is why all types of traders use it. Every trader has to consider and choose his own risk-reward ratio (RRR). The disadvantage is that a fixed RRR is usually not modified according to the current market conditions.
4) Stop-loss order under / above the previous important support / resistance zone:
The last example demonstrating how traders often place their stop-loss orders are S/R levels.
When creating a stop-loss order (long position), it is usually placed under the previous S/R level, which can be seen on the chart above. Stop-loss orders are not usually placed based on the current S/R level (see the chart above), because it carries the risk of the market creating corrections around this level and hitting the stop-loss order without the trend changing at all.
Stop-loss orders based on S/R levels are usually used by medium-term or long-term traders who execute relatively few trades, which allows them to place stop-loss orders further away from the entry points. However, S/R zones can also be useful for intraday traders and scalping strategies.
When talking about long-term strategies, we need to mention that the profitability of a position is influenced by swaps, which are counted into the total profit/loss of the trading position separately. Beware of high negative swaps that can rise to several or even dozens of pips within a couple of days.
Each of the mentioned ways of placing stop-loss orders has its pros and cons and it’s up to the trader to decide which one he’ll choose.
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