Stop Loss – How to Use it and Why it’s Important

The foreign exchange market will always be unpredictable. Economic and political news as well as other factors influence how the market prices move, and sometimes traders unfortunately incur losses that they were not prepared for. This is the reason why knowing about the stop loss and setting one up is important to the trader.

 

What is a Stop Loss?

A stop loss is an order entered by a trader which enables the exit of a trade when a predetermined price level is reached. It helps reduce risk on a trade in case the market moves against your position. It helps you decide on the amount you are willing to lose. For example, you buy EUR/USD at 1.1708 expecting it to rise. With your speculation in mind, you set up a stop loss at 1.1688 which accounts for 20 pips.

 

Stop Loss

 

From the screenshot above, the stop loss is the red dotted line at 1.1688. The green dotted line is the point when the buy trade was entered. If the price moves against the trade and reaches the stop loss, the trade is automatically closed. This prevents further loss by the trader and is also important to a trader who may not be available to watch the market all the time.

 

How to Set up a Stop Loss in Metatrader 4

MetaTrader 4 is one of the most popular trading platforms used by traders around the world. It may look difficult to use for a novice trader but it’s actually quite easy to understand. The procedure to set it up in MT4 is as follows;

  • Open the MetaTrader 4 platform.
  • Displayed on your left-hand side are the currency pairs and their prices. Select the currency pair you wish to trade.

Once you double-click on the currency pair, a dialog box will appear. It has the tabs of buy and sell and also has the option of setting up a stop loss and take profit. This is shown below.

Stop Loss

  • After the dialog box appears, type the stop loss price you have decided on and execute the trade.

 

How to Add a Stop Loss After Placing a Trade

In order to set it up in MT4 after a trade, simply do the following;

  • Choose the trade you want to set up a stop loss from in the terminal window.
  • Right-click the selected trade and select modify or delete order.
  • A dialog box appears which gives you the option to set it up.

 

  • Stop Loss

 

  • Type your selected price point that will act as the stop loss.
  • Click the modify tab to complete the setup.
  • When setting it up, a trader should allow a 5% space between the stop loss and the market price to prevent the trade from being closed earlier and allow for the price to gain momentum.

 

Trailing Stop

A trailing stop is a stop loss order that moves as the price moves. The trailing stop moves as long as the price movement goes in the direction traded by the trader.

 

How Trailing Stop Works

A trailing stop is usually set up in a similar way to the normal stop loss. The only difference is that the trailing stop moves with the price. For example, if a trade moves by 10 pips, the trailing stop also moves by 10 pips. The trailing stop helps the trader to capture profits as the price moves and also prevent loss in case the market moves against you.

Example;

You buy USD/JPY at 110.00 and set a trailing stop loss at 109.70. If the price moves to 110.60 the trailing stop moves to 110.30 by the same number of points. If the price starts to drop from 110.60, the trailing stop will not move since its position was adjusted to 110.30. If the price falls below the 110.30 point, the trade is automatically closed. The advantage is that the 30 pips gained initially from 110.00-110.30 would have been locked in.

 

Our Conclusion

The trailing stop loss and the regular stop loss order are significant to the traders since they reduce the risk of trading in the forex market. Once you learn how to effectively use them in the trading platforms you’ll be able to trade with much greater confidence and a likelihood of success in your investments.

 

To read more articles take a look at our Forex Education section.

 

 

 

 

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