Stop Loss – A Parachute when Trading the Financial Markets
Every financial trader should work with stop losses in order to prevent a loss of trading capital if the market is moving faster than expected. However, there is more to it than just that, because when all is said and done, it is not just about having a stop loss, but of greater importance is should be where exactly one should place the stop loss.
Within the Shaw Academy of Financial Trading, and dealing with people after their first experience with the trading Forex and other financial instruments, we often hear sentences like, “Every time when I enter the market it looks like someone is working against me and, as soon as my stop loss is hit at a loss, the market then moves in the opposite direction – one which should have provided me with profit.”
Let’s have a closer look at this. First of all, a stop loss should be part of every single trade you place. This is paramount. Your Risk Management process should help you decide upon the correct place to set it. If a trader gets the feeling that the market is triggering his stop loss too often and then changes direction, the trader should ask himself if his risk management, and overall trading strategy, is based on the right parameters. Sometimes it helps to review the overall strategy and change it a little bit. Such an adjustment process could take months, or even years, until you find a proper strategy.
When we ask people where they placing their stop losses, the answers are typically not based upon a specific strategy at all. Sometimes we just hear a random amount of pips away from the recent price, often totally completely at odds with the current market action and its current volatility.
So if a trader places a stop loss 10 pips away from the current price, then it could be a sensible distance in market “A”, but it could also be a completely illogical distance away in market “B”. A “one size fits all” approach does not work in the financial markets. A few more experienced people come to us and say that they determine the location of their stop losses in relation to the most recent market behaviour. In theory, this could be a good idea. Why not look at something like market volatility – the range in which a market is moving every day and then let this information provide you with a more accurate your stop loss?
There are a lot of ways to find a good point to exit a market, but at Shaw Academy of Financial Trading we believe that the most important thing is that you use a proven trading strategy to define this exit point before you enter the market.