Using the Stop Loss Option

Being a player in the financial market, you always need to keep in mind that there are two sides of the story. On one side, you make a successful trade deal and earn substantial amount of profit. However, on the other side, there is loss where you lose profits and even the money you had on hand. This is all part of the game. Even in forex trading, there will be times when you will be making huge profits, but there always will be a chance of you enduring a loss due to a bad trade that might potentially eliminate all your time, effort and hard work you put into it.

However, it is not all that bad as there are numerous methods that you can adapt to save you from such losses. These are most precautionary measures that will help you escape big losses. One such tool is the Stop Loss Option that many forex traders use to avoid any substantial losses. Stop loss however does not have a very popular reputation amongst many forex traders because it requires you to endure small losses every now and then in order to avoid the major ones. But being a forex trader, it is essential that you acquire an approach that is long-term focused. You need to look at the bigger picture. What is required is for you to forget about daily losses and think about the big gains you might make in the course of weeks, months and year. Those are the parameters clever forex traders should use to measure their performance in the market.

A forex trader develops his knowledge base with experience, and identifies various tools of money management in the market. Hence, it is important that stop loss is used as an effective tool to oversee your tiny losses in order to maintain a long term profitable approach.

One teaching in life for every person, who is investing on anything, is to remember both sides of the story: success or failure, or in financial terms: profit or loss. It is always suggested to be prepared for both the situations. A great example is that of the housing crisis. Earlier people blindly bought houses as investment properties. Many people placed bets on the ability of low income people to pay off house debts. When you look at it now, when the bubble has burst, the increasing number of houses built had its decreasing effect on their prices. Hence, it is always suggested to play safe and be ready for both situations.

There are different kinds of stop loss methods that are used by traders in the forex trading market. One of these types is the simple equity shop. One important rule that should be followed is to keep one’s self around two to three percent of the total account. This is done as a maximum per trade. In this method, the trader places his order which is based on a certain size. After that, the total number of pips is calculated in order to reach the two to three percent limit.

The other method is the chart based stop. The chart represents different chart patterns that give you an over view of where the next possible move is in a certain currency. These charts act as effective indicator when it comes to identifying movements, and signals as to what should be done with the currencies you as a forex trader hold in the market. This method is one of the most commonly used methods of stop loss.

What are lagging and leading indicators?

There are many tools and indicators that forex traders can and must use in order to always stay ahead of time in terms of anticipating when and what action one should take in the market. Certain tools have been developed on the basis of the norms and trends in the forex market. Certain are self-made tools that have been developed over the years as a result of experience in the market. Two more very important tools that one should make part of their trading armory are lagging and leading indicators. These two indicators help in playing with two parameters of forex trading:

• Timing to buy: To anticipate the correct time and situation to buy forex in the market.
• Timing to sell: To oversee future decreasing trends and making a decision to sell at the right time

The leading and lagging indicators serve as a vital tool to assist traders in determining market trends and in conducting a comprehensive situational analysis, based on which they can make their buying or selling decisions. In the previous section, we laid emphasis on how losses can be reduced using the two method of Stop loss, which is chart based stop and simple equity stop. This section gives comprehensive details of two important indicators: leading and lagging.

A leading indicator provides you a forecast of what the future holds. It helps you identify changes that might happen in the future. In simpler words, a leading indicator tells you what might happen in the future and you can appropriately decide on what action you should be taking. It acts like a weather forecast where you can prepare and take appropriate measure in case there is a storm prediction in the future. However, most might think that leading indicators can help you make a big fortune as you know what the future holds and can act accordingly. In case you see a price hike for a certain currency, you can invest accordingly and so on. This is what most would think about leading indicators. In actuality however, the situation is quite the opposite. These indicators have been named as indicators for a reason. They are based on guesses and anticipation and therefore can never always be correct. You can predict what is going to happen but can never ascertain that because it is, at the end of the day, only a prediction made by human beings. They are bound to fail you. These leading indicators more often than not can misrepresent what will happen in reality. That is exactly why they have been given the name ‘head-fake.

Lagging indicators on the other hand are quite the opposite. They would give you a signal about a situation once the train has already left. Because lagging indicators give you trends after something has happened, they are the much safer option. They require you to adopt a more reactive approach where you can take an action once the situation is in front of you. But as in most financial situations, bigger risks reap bigger profits. Lagging indicators being a safer option involve less risk and hence less profit. Leading indicators are for the big risk takers who would, if successful, reap substantial profits. The key to successfully use these indicators is to maintain a balance between them. Also remember that these indicators are only a guide and nothing else.

Risk Management

Risk management is the most vital aspect in forex trade if you are to become a successful trader in the market. It is the marked difference between your survival and death and the trading market. A forex trader can have the best trading system installed but without risk management, he is bound to fail. Hence, it is essential that forex traders implement the correct risk management strategies in order to be prepared for the worst. Risk management involved tools that aim to control the risk involved with forex trade.

Why is it important?

Risk management is one of the most significant studies as far as forex trade is concerned. It might sound as an easy concept to learn and relate to, but it is the most difficult to implement. There is a general understanding in business; the bigger risk reaps bigger profit. But traders tend to get so disillusioned by the profits that they forget about the failures that might happen. That is exactly why risk management is so important as it keeps you on track and ready for any unforeseen problems in future.

Controlling losses

The best form of attack is defense, a famous cliché that applies to almost all walks of life. Hence is important that you develop a strong back-up strategy. Losses are bound to happen in forex trade but the trick is how you would control those losses. You can either use a hard stop or mental stop to control your losses. A hard stop is when your stop loss is set at a certain level at the trade initiation point. A mental stop is a limit on how much pressure you will be able to take for the trade financially. The real trick is identifying a certain limit to your risks. The lure of huge profits can sometimes be misleading but you need to apply these stops in order to assess and control risks,

Using correct lot sizes

There would be many brokers advertising lucrative deals with unimaginable, attractive ratios. But you need to act sensibly and decide on correct lot sizes. When starting off, it is suggested to always start small and then move on to bigger lot sizes. In the forex market, and considering the rituals of risk management, the best way to manage risk is to be conservative. With a small lot size, you are allowed to be more flexible and manage your dealing more with trade logic, than with emotions.

The bottom line

Risk management teaches forex traders to asses risk and keep it under their control. The more control you have over the risk associated with trade, the more flexible you can be in your approach. The market of forex trade is all about opportunities and how you grasp them. By controlling your risk, you will be able to trade forex in a flexible way even when trends in the market are not favoring you and your dealings. This will help you always stay on toes and be ready for any adverse situations. The difference between a competent forex trader and an ordinary one is the risk management abilities he has.

Summary

This chapter teaches us how to use the stop loss option in order to limit the amount of losses you incur. In the market of forex trade, you are bound to face losses and things can’t always go your way. The trick is to use tools to make your losses minor and plan for the long term benefit. Using the stop loss option, you will only be taking small losses but would be bracing yourself for substantial long term benefit.

There are many indicators a trader uses to foresee future trends and its appropriate action in the market. Leading indicators provide a future forecast of what might happen and the trader can plan accordingly. Lagging indicators on the contrary call for a reactive approach where indications are made once things have happened. It is recommended to use a combination of the two to be more effective and clever in the market.

Risk management is a tool every trader should learn and implement in their system. This helps them stay on track and be more focused. It also allows flexibility and helps you control your losses.