Using stops is one of the most secure trading methods we can employ to ensure that the trading risk we take is limited; if price hits our stop, or our take profit limit order, then we’re out, the trade has ended, it’s either profitable, break even, or a loss. One of the benefits with using stops is the potential peace of mind it can generate; you know that the small, manageable percentage risk you’ve committed to, won’t destroy your trading career if you lose on an individual trade. And if you’re risking perhaps 1% of your account size on each trade and you religiously follow your dedicated trading method on each and very trade you take, then you’re highly unlikely to ever experience a devastating series of losses, that’ll prove to be irreparable to your trading account.
The limiting of losses takes on extra relevance if you’re a novice, just beginning your trading career, when you’ll want to stretch out your original fund as long as possible, whilst your gathering valuable knowledge and experience. It’s highly unlikely that you’ll suffer, for example, fifteen losses in series and approx. 15% of your account size. If you do then the alarm bells should have been ringing earlier that your strategy/method required some serious adjustment, or ultimately terminating, before incurring such a loss.
Hard stop, mental stop and disaster stop can protect your investment
Hard stops are critical to protecting your account, but there are other stop loss methods that should be given equal consideration, as part of your overall trading strategy. For example; what we term “mental stops”. Now the normal advice we’d suggest is that if you’re considering using a mental stop then you may as well use a physical hard stop and in many ways that still holds true. However, you may already have your hard stop placed into the market taken via your platform and in conjunction with your trading plan and risk level, but need to remain vigilant regarding a particular calendar release which is about to be published. The data release may miss the forecast by some distance, the market may violently move against you, requiring you to take emergency intervention to underscore your loss to a minimum. And if you hadn’t intervened your loss would be greater.
There’s also the consideration of what we’d term a “disaster stop”. There’s many traders who (to this day) will turn grey, break out in a cold sweat and require gentle care, when the subject of the Swiss National Bank (the SNB), removing the loose peg they’d attached to the Swiss franc (CHF) versus the euro is discussed. The removal of the ‘peg’ in 2015, caused a spike in value of the Swiss currency that even resulted in many Forex firms going bust. And we’d just like to point out that the reputable brokers; those providing an STP/ECN model, in fact mostly survived intact. Whereas, many of those who were utilizing dealer desk, market maker models – effectively trading against their clients’ positions, suffered catastrophic losses, resulting in the closure of certain high profile brokers. This is the most extreme example of why disaster stops should also be used.
It wasn’t only brokers who suffered, one suffering a circa $250m loss from which they’ll never recover their: reputation, status and share price, many retail traders were wiped out. Sadly they traded without applying the right risk parameters to their CHF trades, they ignored hedging possibilities, left all their trading funds in their account, instead of enough to cover their margin requirements etc. Hard stops, mental stops, or disaster stop, we should never stop our vigilance and overall market monitoring, as we should always recognize the ability for Forex markets to react violently to breaking news.