What is Stop Loss in Forex and How It Works?

In Forex, it is tough to predict the price movement of the trading instruments. At any moment, the market situation may change. If you are fortunate, you can predict the market direction accurately and earn a considerable amount of profit. On the contrary, if you are unfortunate, you can experience a drastic loss. So to limit it, skilled Forex traders use a tool called “Stop Loss” or SL. Probably the most important and vastly use in Forex.

What is stop-loss?

SL is a popular and robust tool that limits your losses. You can consider it as an advanced sell order. If your currency’s exchange rate gets down to a certain point, this tool will sell your currency automatically.

Suppose you have bought EUR/USD at a low price (say 100 USD per unit), expecting the price would get high soon. But after a period, you noticed that unfortunately, the market had gone significantly down instead of going high. So, to prevent more losing you sold them at a lower price (say 80 USD per unit).

From the above event, you have lost 20%, and that is huge. But if you had used SL and set a limit to 5%, your currency would automatically be sold when the market went down to 95 USD.

Benefits:

  1. Reduction of Loss: SL’s core job is to save you from losing. Sometimes, your currency pair’s price can go down silently. However, if you set an SL, you need not be worried because even if the price goes down drastically and beyond your attention, this tool will sell your currency at the SL point.
  2. Automation: As this tool is automatic, you need not sit all the time before your device’s screen. Whenever the price crosses the SL limit, it will sell the currency on behalf of you. For more info regarding automated stop loss, you may visit the official website at Saxo.
  3. Maintaining “Risk & Reward”: Maintaining the risk and reward ratio is essential. And Stop Loss helps to keep the balance. For example, suppose you want to profit a certain amount, and for the profit, you can take risk up to 2% or 4% or 10%. So, you can set your limit by calculating this ratio.
  4. Promoting Discipline: Market emotion is harmful to disciplined trading. SL helps the traders to adhere to their strategy. And it promotes discipline. If you think you can close the trade by using the manual method, you are increasing the complexity. Try to trade this market with simple means as it boosts the profit factors.

Who does like to use it? 

Every trader except position trader (who trades for several months or years) likes to use a stop loss. The day traders (who trade for one day) and the swing traders (who trades for several days or a week) are the actual beneficiaries of this tool. But remember, no matter which trading method you use, you must stick to the trading plan or else you will keep on losing money.

Why does a long-term trader not like to use it?

A long-term or position trader usually trades for months or years. In this specific period, the market can fluctuate several times. It can go down to a drastic level even can go up. But a position trader analyzes the market for several days or weeks, and then they start trading. So, some short-term fluctuations do not bother them. They aim at the final days of their trading.

Suppose you are a long-term trader. You have started trading for one month, expecting that the currency’s price would go high at the end of the month. But mistakenly, you have set an SL point, and right after your starting, suddenly, the price got down, and it crosses your limit. So, this tool has sold your currency. But you knew the price would surely starting to go high from the middle of the month.

So, think again, if you did not set this limit. Always try to trade this market conservatively as it will help you to manage the risk profile in a standard way.