Experienced traders can be rendered open mouthed when they peruse trading forums and read reports from novice traders, who’ll continually trade without stops. Capital preservation is one of the key factors when you trade markets; your risk has to be monitored and limited, at all times. During your early, fledging, months and years, one of your main objectives should be to stretch out the first account you open (with a relatively small amount of cash) for as long as possible, during your initial learning period. In doing so, you’re indirectly paying for a valuable education.
You have to very quickly establish your tolerance to risk and decide how much of your account, as a percentage, you’ll risk on each and every trade. You might prefer to risk only 0.5% of your account, or you could decide to risk 2%. Generally, it’s a decision largely based on what style of trading you choose. For example; scalpers might risk 0.5% on each trade, swing traders might prefer to risk more on each trade. It’s important to note that this initial decision is absolutely vital to your progress and it sets a benchmark for your decision making, for as long as you’re involved in trading.
It’s at this juncture that you need to apply some obvious logic; if you don’t apply a stop to your individual trade, how can you possibly limit your risk? You can’t. It really is that simple. Unless you’re using stops, for each and every trade, your risk is not predetermined, you’re trading without any self control, or discipline. Unless you apply stops, you’ll be trading freehand, making random and perhaps emotional decisions, as to when you will close a trade at a loss.
There is one major reason why many novice and intermediate level traders will trade without stops and its relevant to their doubts and inexperience, as to where to place stops. The rules of placing stops is very simple and the application is straightforward. The process, of where to place stops, is best illustrated by considering day trading as a style.
Firstly; you need to place your stop where you’re convinced that you’ve predicted the current trading direction incorrectly. You’re not wrong if your stop is activated and a loss is registered in your profit and loss. You’ll have presumably followed your trading plan precisely, price has simply moved in the opposite direction to your prediction. A prediction based on the: facts, data and historical precedents, which you’ve painstakingly adopted, as part of your trading strategy. You may have been bullish EUR/USD, but the market has turned bearish, not because you failed to analyse your economic calendar correctly, a breaking event may have occurred, causing a change in the value of either the base, or the counter currency.
Secondly; if you’re a day trader you might want to consider not only where you think your trade direction may be incorrect and where the trade is invalidated, you might want to place your stop near to or precisely at, the day’s high or low. This could be the most objective and realistic area to place your stop. For example; let’s suggest you take a long trade on EUR/USD, as price is above the daily pivot point (P.P.) and in your opinion the currency price action is bullish. You might consider placing your stop at the daily low, an area perhaps below the daily P.P. In doing so you’re making the judgment that if sentiment reverses, from bullish to bearish, that change in sentiment and market direction will be absolutely indicated by reaching the daily low. You could simply reverse this process for a short trade; you’d place your stop in an area close to or at the daily high.
This placement of stops also has an unforeseen beneficial consequence; you’ll immediately learn how to calculate you risk per trade on every given trade. You will have to use one of the various free calculators your broker offers, to establish your exact position size, to ensure you’re only risking perhaps 0.5% (as a day trader) on each individual trade. The irony of this consequence is often lost on novice traders as they desperately search for a trading strategy, but it’s worth reinforcing. You can forget any ideas of success by way of strategies. As unless you control your precise risk, for each any every trade, principally by the use of stops, your chances of success are severely hampered.
