A common objection to using stop-losses is, ‘I don’t use stop losses because every time I do, I get stopped out of my trade and the market then turns my way and I miss out!’ If this happens regularly, it is likely the position of the stop loss may have been incorrect or a bit too tight.  

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Giving a trade room to breathe allows for dips. Some currency pairs can move 100-200 pips a day.

 

Where to place stop losses?

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So, where is the best place to put a stop-loss? Too close and it's almost sure to be hit and too far and what’s the point with a big loss. A strategy should aim to stay in the trade as well as provide an acceptable loss if the strategy fails. The area the stop-loss should be the point that if hit, the signal to get out of that trade is hit. A stop-loss that closes a position right before a run could mean the level selected was at a key turning point. 

Two common textbook ways to consider when setting the stop-loss level are outlined below. Knowing where also requires understanding how to calculate pip values and how much each pip will cost based on the lots traded. 

1) Percentage of your account – Risk profile and the amount willing to risk

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• Stop loss position is determined by the amount willing to risk. Example is a stop-loss placed exactly 2% risk level away. 

• If the account balance is $10,000, a 2% risk management limit is willing to risk a $200 loss. The stop is placed by calculating the number of pips resulting in exactly $200 loss, no matter where on the chart that sits.

• This strategy is considered by many traders to be inefficient and an incorrect way of placing stop losses. It totally ignores what the chart and analysis says about the market and therefore placing the stop at a random, insignificant point. This stop could actually end up being placed at a level too far or too close based on ideal market levels.

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2) Technical analysis - Significant areas on the charts

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• Learning to recognise ideal entry and exit points such as support, resistance, highs, lows, volatility and even fibonacci may help with stop-loss placement. A trader can determine where to put the stop-loss to best suit the levels without being cut out early. 

• Once desired levels on the charts are analysed, calculate the number of pips this is from the entry level and determine how many contracts need to be placed in order to stay within the (e.g. 2% loss) risk level for that distance.

Other potential ways to determine where to put the stop according to textbooks: 

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• Maximum distance from today’s high to today’s low

• Maximum of yesterday’s close to today’s high

• Maximum of yesterday’s close to today’s low​

• Focus on prior correction low/high points

• Try go below round numbers or halves

• Be below the 30-week moving average

 

Trailing Stops

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Platforms allow traders to place stop-losses which will move as the market moves favourably. Trailing stops are useful if traders predict a run correctly and wish to prevent losing profits if the market turns around.

The trailing stop-loss follows the price and if for example is set to remain 50 pips from the market price (unless the market falls below original entry point), the stop-loss will trail the price high. As the market goes up (if in a buy position), this stop-loss will move up staying 50 points lower than the market. If the market turns 50 points lower from the highest level, the position will be closed.

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