Risk management is a vital aspect of any successful trading strategy. There is perhaps no more essential piece of risk management than setting a stop loss - and here's why...
In this blog we take a look at:
- where to set a stop loss
- the difference between a trailing stop loss and a trailing stop limit
- how to set stop loss in MT4
- how to set stop loss in Bittrex
- how to set stop loss in Binance
Want more risk management tips? Read 4 Essential Risk Management Tips...
Why is Setting a Stop Loss Important?
Setting a stop loss is key to limiting the risk in a trade. Without a stop loss, the trade will only be closed when you manually do so owhen you receive a margin call, if you are using margin, and your broker closes your trade for you.
Key to limiting risk is limiting your losses on any given trade and setting a stop loss is vital to accomplishing this. The lack of a stop loss can lead to losing an entire portfolio on a single trade.
Where to Set a Stop Loss
There are different criteria for choosing where to set a stop loss. If you’re not using margin, a percentage basis may be fine. For example, you might buy $1,000 worth of stock and set a stop loss order to trigger at 10% below the purchase price. This ensures that you won't lose more than 10% or $100 on this stock. This philosophy about the setting of the stop loss is more suitable for long-term fundamental trading.
If you are trading based on a technical strategy that identifies a particular take profit and stop loss, then you should follow those recommendations. In Forex trading, you should set a maximum loss for every trade you make and identify the stop loss for each trade. Then you should size your position based on the maximum amount of capital you can afford to lose if the stop loss gets triggered. Typical limits on maximum loss per trade range from 2-5% of your account.
You should always set a stop loss that is compatible with the potential reward for a trade. For example, you should never set a stop loss at 5 pips below the entry point, only to set a take profit 5 pips above the entry point. This is a 1:1 reward-to-risk ratio and would require you to succeed at over half your trades to be profitable.
Even a 2:1 reward-to-risk ratio would require you to succeed at 33% of your trades to break even. Only open trades that carry at least a 3:1 reward-to-risk ratio. This requires only a 25% success rate to break even and you will be spending your time monitoring trades that offer good potential for reward.
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What's the Difference Between a Trailing Stop Loss and a Trailing Stop Limit?
A trailing stop is a type of stop loss that is triggered when an asset has lost a specified amount of value. For example, in the Forex market, you could set a trailing stop so that your position will be closed when it loses 15 pips.
This is a great way to put a limit on how much a winning trade can turn against you. If it keeps going up, the trailing stop loss follows it. The trailing stop loss trails the specified distance behind the extent of the price. That’s where the name “trailing stop” comes from.
There are different kinds of trailing stops. Understanding the underlying order types that make them different is essential to understanding how they work.
A trailing stop loss order creates a stop loss that, when triggered, creates a market order to close the position. What this means is that the position will be closed immediately at the market price when the stop loss is triggered. If you create a trailing stop loss order for a position on EUR/USD at 1.3314 to trigger when it loses 14 pips, it will trigger at 1.3300 and your position will close at the price when the market order is executed. With a market order, there is no guarantee that you will get the price that you see when the order is created.
A trailing stop limit creates a limit order instead. Once the stop loss level is reached, an order will be created to only close the position if you get a price at that level or better. So, using our example above, assume we have a position in EUR/USD at 1.3314 and we set a trailing stop limit order to trigger at 14 pips. When the stop loss level gets hit, it will trigger a limit order to close the order at 1.3300 or better.
So, if the price dips down to 1.3299 between the time the limit order gets triggered and the time it would be executed, the limit order would not be executed. It would sit there and wait for the price to rise to at least 1.3300 before executing.
This ensures that you do not lose more than 14 pips from the price where you set the stop loss order. However, the risk is that if the price never gets back up to 1.3300, the limit order could hang out there indefinitely. If the price continues to fall and never reaches 1.3300, however, you would be exposed to losing even more on the trade.
With a trailing stop loss order, you know that when it is triggered your position will be closed. The risk is that you don't know exactly at what price it will be closed. With a trailing stop limit order, you don't know that your position will be closed, but you know that if it is closed, you won't get a worse price than the stop loss level. In a market that is not volatile, usually, a regular trailing stop loss order will be fine.
But in assets that are very volatile, slippage between the order submission and its execution may negatively impact your profits. In those cases, a trailing stop loss limit order may be better. But if you do use a trailing stop limit order, it may be wise to be where you can intervene if the trade begins to go substantially against you.
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3 Stop Loss Forex Tips
How to Set Stop Loss in MT4
In MetaTrader 4, you can specify a stop loss when opening a position. With the one-click trading, you can click the buy or sell button to open the New Order interface. You can set the stop loss and take profit right there on that interface.
If you enter a position and did not specify a stop loss at that time, you can modify your existing order to set a stop loss. On the Trade tab of the Terminal subwindow, you can see your active positions. Right-click on the order you want to modify and choose "Modify or Delete Order." At this point, you can set a specific price for your stop loss and your take profit.
When it comes to how to set a trailing stop loss in MT4, you can right-click on your entry point on the chart and hover over “Trailing Stop” on the submenu, then specify the number of pips you want for the trailing stop loss. You can select “Custom” to type in a particular number of pips that doesn’t appear on the menu options.
How to Set Stop Loss on Bittrex
Setting a stop loss limit in the Bittrex trading platform can be performed by clicking the dropdown under the label “Order Type” and selecting “Conditional.” In the Bid or Ask field you then specify the price at which you want the limit order to be executed. In the “Quantity” field you can specify the quantity that you want to buy or sell when the stop loss is triggered.
Under the Condition field, specify the condition that you want to trigger to the stop loss and the price at which it should be triggered. When the condition is triggered at the price specified, a limit order will be created for the price specified in the Bid or Ask field at the quantity specified. You can set your limit
order for a price below the stop loss level to ensure that the order gets filled. Click the “Buy” or “Sell” button and read the summary the interface gives you. Click “Confirm” to proceed.
How to Set Stop Loss on Binance
To set a stop loss limit in the Binance trading platform, click on the Stop-Limit tab in the lower right-hand corner of the page. Set the stop price at the level where you want the stop loss to trigger. Then set your limit price at a level lower to guard against any slippage that they occur between order submission and order execution.
Next, put in the amount of currency that the stop loss pertains to. You can use the percentage buttons to specify 25%, 50%, 75%, or 100% of your position. Click the “Buy” or “Sell” button below the interface and read the message on the popup and be certain that it makes sense to you. Then click “Place Order” to go through with the order.
Ready to set a stop loss?
Understanding the stop loss order is an indispensable tool when it comes to limiting your risks when trading. Understanding the limit and market orders that underlie the stop loss order and stop loss limit order go a long way toward using them effectively.
Set a stop loss at areas in the market where you know your predictions about the market are no longer valid. There is no point in letting the market slip any further down when it is just costing you money you know you won’t get back. Proper use of a stop loss can protect your valuable capital every time you trade, ensuring that you can maintain a long trading career.