Just about any forex trader who wishes to avoid watching the forex market constantly when they have a position will want to consider leaving stop orders in the market to help them manage their risk.
The types of stop orders most commonly used by forex traders to manage risk on trading positions are stop loss orders and trailing stops. The following sections describe in greater detail how a trader might use each of these important order types.
Using Stop Loss Orders
Stop loss orders are those placed in the market at a rate worse than the prevailing rate and are used to limit the risk on a trading position in case the market moves against it.
Stop loss orders are usually executed at the best possible price available in the market once the set order level has traded. The difference between the order level and the actual level the stop loss order is filled at is known as slippage.
Traders familiar with basic technical analysis methods will typically place stop loss sell orders on long positions below support levels, and stop loss buy orders above resistance levels when going short. This strategy helps protect the stop loss order from being executed and gives the original position a greater chance to become profitable.
Furthermore, a number of other technical indicators are often used in addition to support and resistance levels to set stop loss levels. These indicators include moving average crossovers which can give a trader a sense of when a market has reversed its prevailing trend. Some traders also use pivot points to set stop levels.
Basically, stop loss orders have saved many a trader from what would otherwise have been steep losses. Nevertheless, for every wise trader that has saved money by using stop losses, many more people that are no longer trading, have not.
Using Trailing Stops
The technique of trailing stops become useful once a position has become significantly profitable. The process involves moving the existing stop loss level on a position to a better level – ideally beyond the trade’s breakeven point – in order to lock in profits.
Overall, trailing stops give a trader the benefit of protecting profits made previously. They also allow the trader to continue holding a profitable position in a trending market until the market turns, in which case the stop order will automatically liquidate the position to protect whatever profits have already accrued.
The important motivation behind using trailing stops is to let your profits run. Using this strategy allows traders to stay with a position for a major currency move after having gotten in at a good initial level.
Such a situation could have a long term trend trader holding a position for months – making outstanding profits in the process – until the stop is eventually executed on a market reversal and their profits realized.
Of course, when the trend eventually reverses and the trade is stopped out this represents the perfect opportunity for the trader to calmly reassess the market and determine whether or not they wish to reenter.
They might then choose to get back on the same side of the market, or perhaps take a contrary position if the market has shown substantial signs of reversing further.
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