EDUCATION ARTICLES

Managing and protecting capital is the primary responsibility you bear as a trader. If you lose all your capital in trading, you won't be able to recover the amount lost, and consequently, you'll be forced to exit the trading arena. The only tool for capital management and protection is the use of stop-loss.

What is Stop-Loss?

Stop-loss, also known as SL (short for Stop Loss), is a mechanism used to halt a trade when the trader's analysis and strategy prove incorrect. It closes the position to avoid further losses or limit profits. Traders use stop-loss orders to close losing trades or prevent profits from eroding.

Stop-loss can be set at a certain profit or loss level, or even at the breakeven point of a specific trade.

For example, if a trader buys 1 lot of gold at $1,900 and, based on their strategy, believes that if the price drops to $1,890, it could decline further, they would set their stop-loss at $1,890.

If the price reaches $1,890, the trade will be closed at a loss, preventing additional losses. Now, let’s assume the trade is in profit and the gold price has risen to $1,920. After reviewing the chart, the trader believes the price could rise further. However, according to their analysis, if the price drops back to $1,900, it is likely to fall again. Thus, they decide to move the stop-loss to their entry point at $1,900. If the price hits this point, the trade will close at no gain or loss, an action known as risk mitigation.

The Importance of Stop-Loss in Trading

Setting a predefined exit point for a losing trade not only helps minimize losses and allows traders to move on to new opportunities but also reduces the stress of holding a losing trade without a plan in place.

The primary purpose of a stop-loss is to ensure that losses do not spiral out of control. In fact, the stop-loss point should be considered the "core element" of your trading strategy.

Major Mistakes When Setting Stop-Loss

Setting Stop-Loss Too Close

The first mistake is placing the stop-loss too close to the entry price, leaving little room for price fluctuations before the market moves in the desired direction. Always consider the volatility of currency pairs when determining your entry point.

Using Trade Size to Set Stop-Loss Levels

Setting stop-loss levels based on trade size or the "number of points" is not a sound approach. Stop-loss settings should be based on market behavior.

Setting an Excessive Stop-Loss

Some traders make the mistake of setting their stop-loss too far from the entry point, increasing the number of points the market needs to move in their favor. The basic rule is to place stop-loss points near the entry level but in a calculated manner.

Placing Stop-Loss Directly at Support or Resistance Levels

It's important to consider support and resistance levels, but avoid placing the stop-loss directly on these levels. Instead, leave some room to prevent false breakouts.

Three Rules to Follow When Using Stop-Loss Orders

Do Not Let Emotions Influence Your Stop-Loss Decisions

You should determine your stop-loss adjustments before entering the trade.

Trailing Stop-Loss

The trailing stop involves adjusting the stop-loss in favor of a profitable trade, helping secure profits and manage risk.

Do Not Widen the Stop-Loss

Expanding the stop-loss increases risk without any added benefit. If the market reaches your exit point, you should close the trade.

Conclusion

Ultimately, as with all aspects of trading, setting a stop-loss is both a science and an art. Markets are constantly changing, and what works today may not work tomorrow. You will come closer to becoming a professional risk manager if you regularly review your stop-loss strategies and document your thoughts and trade results in your trading journal.

Follow us on Telegram via the following link: Point Trader Group - Telegram and on social media via this link: Click Here.