Stop Loss Orders – Risk Management Basics

What Are Stop Loss Orders?

 

I think I can speak for all of us when I say that losing money is something we all hate.

But you know what the only thing worse than losing money is ?

Losing all your money.

Losing all of your money on one trade is an absolutely disastrous situation, it generally shouldn’t happen, but in some cases it does, and if it does happen, the pain it will inflict on you will be massive.

Stop loss orders were created so that there is always a limit to how much you can lose on any one trade, if you were to place a trade with no stop-loss on, then theoretically you can lose an unlimited amount of money.

In reality though your trading broker will close your trade when all the money in your account has been depleted, but still, losing your entire account on one trade is a situation you really don’t want to be in.

 

The Worst Case Scenario

 

Now I’m going to show you what can happen if you fail to place a trade without a stop-loss order.

Keep in mind this Is a very real example of what thousands of traders go through everyday in the markets.

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I want you to look at the pin bar I’ve marked in the image above.

Imagine for a minute that you have just watched someone place a sell trade based upon seeing the pin bar above, now also imagine that they have failed to put a stop loss with the trade.

image of what happens if you dont use a stop loss

Look what happens next.

The market surges higher, had the trader put a stop-loss on they would’ve lost a small amount of money, but since they didn’t, the loss on their trade is now much much bigger.

Being faced with a very big sudden loss like this causes the trader to be caught in a psychological trap.

This trap is due to the trader not wanting to accept his loss, he’s so confident in his ability to predict the market that he feels there no need for a stop, whats the point of having a stop if he knows where the market is going to go ?

You see traders who have had the market move against them with no stop placed are optimists. They genuinely believe the market will return to the point where they placed their trade, giving them the opportunity to close for a small loss or even better, break even.

Looking at the image above I’ll give you a walk through of what happens in the traders head when the market moves against him.

After the initial up-thrust where the market moved past their entry into the pin bar trade, there was a small move down, this makes the trader not using a stop think that the market is moving lower again, so he waits in anticipation that the market will move back to the point where he placed his trade.

As you can see this doesn’t happen, the market begins to move higher again, at this point the trader has withstood so much trauma of being at a large loss that he can not withstand the pain of having the market move against him again.

This means he will close his trade finally accepting the loss.

None of this would have happened if the trader had put a stop on his trade.

This is why it’s absolutely essential you put a stop-loss on every trade you place.

You do not want to be in the same situation as the trader described above.

 

How Do I Know All This ?

 

When I started out in the world of forex trading there were many times when I didn’t put a stop-loss on my trade, not because i wanted to lose all my money, but because no one had told me what they do, it sounds stupid but at the time I wasn’t aware books were available which teach you about trading, if I had know there were, I could have stopped myself unnecessarily losing money.

Fortunately because this happened at the beginning of my trading career I didn’t really have much money to lose. I think across the three accounts I had money in, collectively I lost around £4300, which is still a lot of money but keep in mind this was over a four-year period.

This is how I know so much about what a trader who trades without stop goes through, because I use to be that trader !

I’ve had the painful experience of the market going against me and it really isn’t a good feeling.

This why I have made this article for you. So you don’t go out and repeat the same mistakes I did !

 

How To Place A Stop Loss Order

 

By now you should understand the importance of putting a stop-loss on every trade you place.

What I’m going to do now is run you through how to actually place the stop itself, because some people are trading forex using an online broker and some are trading through MT4 I’ve split this section into two parts:

The first is how to place a stop-loss using MT4.

The second is how to place a stop using traditional online forex brokers.

 

Placing A Stop Using MT4

 

Placing a stop on MT4 is a painlessly easy process.

First, you need to right-click on your charts and move your cursor over the option labelled “Trading”.

A few new options will then pop up, the one we are interested in is labelled “New Order”, it should be found near the bottom.

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A new box will open on your screen.

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This screen will now appear, go to the box labelled “Stop Loss” and type in the price at which you would like your stop-loss to be placed.

After all this is done you simply place the trade and can rest assured that your losses are limited.

 

Placing A Stop Using Online Brokers

 

Most people I know who trade do so through an online trading broker. They use MT4 for charting purposes, but execute their trades through their trading brokers platform.

All trading brokers are relatively similar in the platforms they provide to users but there may be slight differences between each one so forgive me if the layout and terminology used by your broker is a little bit different compared to what I use below.

So how to place a stop using an online broker:

To begin with you will need to click on which type of trade your going to place, when you have done that a new screen should open, similar to the one in the image below.

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Now you need to navigate to where it says “Stop Loss” and type in which price you would like your stop-loss to be placed.

Upon doing this the only thing left for you to do now is click submit button at the bottom.

And just like that you now have a stop-loss on your trade.

 

Moving Stops After Placing A Trade

 

As well as using stop losses to protect ourselves from losses we can also use them to protect profits.

And protecting profits is just as important, if not more so, than limiting losses.

This means you can place a trade, watch it go into profit then move the position of your stop so that you can take some of the profits off your trade.

Say you’ve placed a trade which is in profit of around £200, by moving the stop you can take £100 profit off of this trade and still continue to have the trade running so it can still make you more money.

How Do I Do This ?

 

Its simple really, if you’re using MT4 then you need to navigate to the trade tab found at the bottom of the window, then right-click on the current trade you’re in.

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A small box will pop up, click on the option labelled “Modify or Delete Order”.

image of stop loss placement MT4

This window will then appear.

All you need to do now is change the price of your stop-loss so that its above the price at which you entered at.

If your trade was placed at 1.12700 and the market is now at 1.13000 to lock in profits the price of your stop needs to be above 1.12700.

When you’ve done this click “Modify” found at the bottom of the box to apply the changes to your trade.

What If I’m Using An Online Trading Broker ?

 

If your trading using an online forex broker then moving a stop is even easier.

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By the way not all broker platforms are the same so things may look at little different to what you see here.

This is a trade I recently placed on USD/JPY.

You can see there are two buttons: one called AMEND and the other labelled CLOSE, to move the position of the stop you need to click on the AMEND option.

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All you do now is simply change the price of the stop level so that its above your entry price.

Summary

 

Proper use of stop losses is essential to your success in the markets, by understanding the many uses they have you can trade more confidently, I thought I’d highlight the possibilities of what can happen if you fail to use stops altogether and I think we both agree that not using them would be a big mistake.

The main takeaway I want you to have from this article is that you must always use a stop loss, no matter how confident you are of a trade working out. Failure to use a stop will either result in you losing a large chunk of money or all of the money in your account, by always having one placed, the amount you can lose will always be limited and you can put yourself in the best possible position to survive longer in the markets.

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