Forex Trading Articles - Don't Be Mental With Your Stops

Don't Be Mental With Your Stops

Feb 7 • Forex Trading Articles • 910 Views • 1 Comment on Don't Be Mental With Your Stops

Is there any difference between having a normal stop loss order, or trading with a ‘margin call’ stop? After all your position gets liquidated when you want it to be..

Is there any such thing as trading without a stop loss order? They can be hard physical stops or mental, but they’re always there, because at some point (win or lose), you have to get out of trade..

Let’s move aside my prejudices versus the ‘no stop adrenaline junkies’ and objectively consider the benefits of not having stops for a moment. OK, that’s that done with, time’s up, that took all of two seconds, it’s as I first thought, there’s never a valid reason or time to trade without a stop loss order.

It doesn’t take any large amount of statistical research to understand why you cannot (day) trade currencies without using stop losses. An interesting exercise is to consider the use of target prices, (take profit orders) when debating the value and use of stop losses.

If you never trade with a target price or take profit order, and always let your winners run, but trade with stop loss orders then probably your stop loss will be hit regularly. You may take many consistent small loses but then one day, every now and again throughout the trading year, you’ll get that huge gigantic winner because you had no target price, or take profit order in place.

Let’s swap the concept of target price with stop loss and reverse the scenario. If you never have a stop loss order and always let your losers run then what will happen? Your stop loss order will be hit regularly and more often than not you may experience many small consistent wins, but then one day you will get that huge gigantic loser due to not having a stop loss.

Let’s also explore some other mathematical concepts. As we enter any trade we accept that we’re ‘betting’ on a two horse race; we have a 50% chance that price will either go up or go down. Let’s use a model of either 100 pips, or 100 pips down. If you switch your risk to reward ratio aiming for just 5 pips and leave your SL at 100 pips which one is going to get hit more often then not? Trading without a stop loss order is similar to hitting those five pips consistently, there will be those days when you hit your 100 pip SL.

There are probably exceptions to not using a stop loss order, I can’t think what they are but if you can justify it then you need to make sure that you have the correct method for that exception to the common sense rule, otherwise you’ll be making very small gains before eventually losing the account.

Position traders are put forward as the possible exception for not using stop losses, but as an experienced trend and position trader I can confirm that I’ve always used stop losses at the HH or LL of where I perceive the turn in sentiment occurring. The stop may be in excess of 250 pips but it’ll still be used. Even “disaster stops” should be placed, for those ‘just in case’ moments, which do happen, maybe 2-3 times a year from unexpected news (BoJ/SNB interventions for instance). Now if you are a trend or position trader and you haven’t put a stop (dynamic trailing or otherwise) in place on a particular trade (which is in positive territory) then you could see your good trade ‘going bad’ wiping out months of profit.

 

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If you’re lucky, a natural, (or frugal), you won’t blow an account on the first leg of your trading journey. Blowing up an account isn’t always a bad thing, some positives can emerge. It’s a good lesson that’s not easily forgotten if the dent to your savings is something you can still come back from. If you then manage your positions correctly you should never experience another margin call or account blowup. Even the great collapse during the economic meltdown in currencies in 2008 should have been sustainable and profitable if you positioned yourself correctly.

When you buy hardware you can buy an extended guarantee, in trading it’s called a stop loss order. If you invest in a financial product you need to establish how much, relatively to your wealth, you’re investing. How much you should risk should be a function of your expectancy. With absolutely no stop loss (physical or mental), you are basically investing all of your capital on an individual trade. The only instance were you could justify this is if you know with 100% certainty the trade will be successful. You can never have a 100% probability of success for a single trade, therefore you need to limit risk on each single trade. That automatically means you have to use a stop loss and it has to be physical not mental. There is no other solution.

Physical stop loss orders can be considered as mental stops taking physical action. Mental stops are when traders decide in clear terms before taking the trade at what point they’ll realise they’ve been wrong, close the trade and take the loss. This needs to be clearly established prior to the trade. Plan for the worst scenario, decide on the order size accordingly, and then enter the trade. The HH or LL at the turning point in trend or sentiment is where the stop loss order should be placed, this takes any guess work away.

Traders, particularly new traders, who currently lack the discipline and experience to follow their own rules should always avoid mental stops. They should use stop loss orders. Stop losses offer up freedom as a trader. Can retail traders afford to watch the price all day, whilst babysitting their charts? No, so use stop loss orders..and that’s an order…

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