Lesson 2: 3 Rules for Stop-Loss Orders

In the previous lesson, you’ve dug deep into stop-loss orders and how setting these up can help you limit potential losses and lock in profits. Let's review,  

1. A stop-loss order is an effective risk management technique because it protects your capital from adverse market movement. 
2. A stop-loss order is an order that will be triggered once the market has reached the predetermined loss level.  

With these benefits, you're assured that the market will do your trading capital no harm. That's true, but only if you use the stop-loss order properly.

This lesson will equip you with three rules when using stop-loss orders. 

Lesson Highlights

• Setting up a stop-loss order is an effective risk management technique as it automatically exits a losing trade when the market reaches the stop-loss level set by the trader.
• Trailing stop order follows the market as it moves to secure the profits the position has been making. Essentially, a trader who trails their stop can profit from the market while protecting their trade position.

What is a Stop-Loss Order? 

When you're in the forex market, you ride the volatility it gives. While market volatility and fluctuation provide profitable opportunities, these can also put your position and capital at risk.  

A sudden market snap may make your trading position run at a significant loss. With that risk, you must monitor the market closely and act on it promptly.  

But do you have to do it manually? Well, it's your call. However, a more effective way of mitigating that risk is by placing an SL order. 

The stop-loss (SL) order is a forex order that automatically exits your losing position. This way, you mitigate capital damage by preventing you from having further losses.  

You place your SL order below or above your entry price, representing the loss you're willing to take for that position. 

When you set a stop-loss order, you;  

• Place it below your entry point if you're going long. 
• Set it above the market if you're entering a selling position. 

Rule 1. Disciplined traders use stop loss. 

You're not a gambler. 

That's one thing you must instill in your mind when in the financial market. The best way to ensure that you're not gambling when trading is to plan your trade, set predetermined levels, and be consistent with it.  

Disciplined traders have a trading plan and strategies they follow whenever they set foot on the market. One integral part of their plan will always be setting stop-loss orders.  

The SL level you put represents the expiration of your trade's validity. Once the position reaches the stop level, it's basically done because it exhausts your risk tolerance for that specific position. 

But what if you missed out on profitable opportunities because an SL order exits your trade? 

Well, disciplined traders are not bothered with the possibilities that might come after the validity of their trade.  

Remember, while profits are essential, preserving capital is paramount. Strictly following your SL order cultivates a disciplined mindset necessary for long-term success. 

Rule 2. Don't let your emotions take over your stop. 

Emotion and trading should never come together.  

That's because emotional trading brings more harm than good. If greed, excitement, and fear take over your position, it will suffer because these emotions cloud your trading judgment and bring negative results. 

Oftentimes, SL orders are adjusted because the emotional traders tend to have their greed and fear get in the way.  

But does that mean that you should never adjust your SL level?  

No, you can adjust it – but never during the heat of the trade. Your SL adjustment should be determined before you execute your trade. If you're changing your SL, you should consider your risk tolerance and the current market condition. 

Rule 3. Trail your stop to lock in potential profits.  

So, is there no profit at all when you set a stop-loss order? 

If you're concerned with the missed profitable opportunities with SL order, you can trail your stop to lock in your profits.  

Unlike stop-loss orders, trailing stop uses a percentage that moves with the market's current price. What your trail level does is follow the market as it moves to secure the profits your position has been making. 

But what will happen to your trail level if the market reverses? The trailing stop level won't follow the market movement when it experiences reversal. 

It will remain at its last peak level and exit the trade once the market crashes against it.  

Understood the rules? For the next lesson, you'll know the grave mistakes traders often make when setting a stop loss order. Warning: these mistakes can wipe out your account!