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Currency Trading Tips - 3 Reasons Why You Should Trade With Stop Loss

A stop loss order is a common order used by experienced forex traders to limit their risk. Simply put, by setting up a stop loss order, the trader actually define in advanced the amount of pips and money he is willing to risk per position. For example, if a trader goes long on the EUR/USD pair at 1.5500 trading 1 regular lot (i.e, $100,000) and sets up a stop loss order at 1.5450 it means that the trader risks 50 pips or $500. If the stop loss order is hit at 1.5450 the trader will lose the above amount but no more than that.

Many newbie forex traders trade without a stop loss order. Others set up stop loss but when it is close to be hit they tend to move the order (increasing their potential risk) or just cancel it. If I have to mention only one single thing I learned as a trader, here it is: Never enter a trade without stop loss order. If you do enter a trade without stop loss order - you WILL fail in the long run.

There are 3 major reasons why you should always use a stop loss order when trading forex:

1. DISCIPLINE: Discipline is a key to success in the forex arena. Assuming that you use a proven trading strategy (otherwise you are not in the right business...), this strategy MUST include stop loss rules. Once you do not use stop loss you break the rules of your own strategy which is typical to the losing 95 percent of the herd. As discipline is 90% of the forex game, you cannot win the game if you do not possess it. Successful traders, the top 5 percent, always use stop loss.

2. MONEY MANAGEMENT: Another major key to success. If you have a good money management strategy (and you should), it means that you risk no more than 1 to 3 percent of your trading capital on each trade. As mentioned above, your risk is determined by the position of your stop loss order. If you do not use stop loss, it means that your risk is virtually unlimited. Without a stop loss, nothing stops your trade from going against you until you receives a margin call. For those of you who do not know, in the forex world a margin call means - "Game Over".

3. RISK MANAGEMENT: Maybe THE key element of currency trading. In order to be a profitable trader in the long run, you MUST have a reasonable risk management plan. It means that your risk/reward ratio on every trade should be at least 1:1 (I prefer 1:3). For example, if the track record of your trading strategy shows that 60% of the trades are winners but you risk 20 pips for each 10 pips profit (i.e, risk/reward ratio of 2:1), after a hundred trades you will find out that you are losing money [10pipsX60- 20pipsX40 = (-200pips)]. If you trade without stop loss, it means that your risk is unlimited. Hence, your risk/reward ratio CANNOT be in your favor. Just for the seek of illustration, let's say that you have a magnificent trading system that produces winners 90 percent of the time. Now, imagine you trade without a stop loss order. So out of 10 trades let's say you have 9 winners in a row, 50 pips profit each (450 pips profit so far). But then you have this 1 out of 10 loser trade and the market goes against you. Since you traded without a stop loss, your risk is unlimited and you can easily lose more than the 450 pips you gained in the last 9 trades. One lousy trade wipes out 9 successful trades. Bottom line: you are losing money.

New traders tend to underestimate stop loss orders. I hope you got the point by now. However, there are many other factors and key elements that one should master in order to succeed as a forex trader. Remember - forex trading is a relatively new business opportunity that was not available to the public just a few years ago but, at the same time, forex can be risky and frustrating. If you are new to currency trading, it is highly recommended that you get a proper "forex education" before you start trading with real money.

Want to know more? Visit Currency-Trading-Articles to get guidance on how to start trading forex with low risk and without quiting your 9-to-5 job.

Subscribers of Currency-Trading-Articles (subscription is free) also get two free must read e-books.

Article Source: http://EzineArticles.com/?expert=Ben_Lipski

5 comments:

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