Lesson 1: What is a Stop-Loss Order and Why It Is Important?

The forex market snaps every minute, if not, every second. While this brings you profitable opportunities, market volatility can also put your position at risk.  

A minute market change may make your position lose the value of pips. Hence, it's critical to closely monitor your position and act on it promptly.  

With a stop-loss (SL) order, your losing position automatically exits the market even if you're nowhere near your device. You must set an SL order, and your broker will exit your trade for you.  

Lesson Highlights

• There are different types of forex orders a trader can utilize to make their trade execution efficient and profitable. The common orders that most brokers offer are market orders, limit orders, stop-loss orders, and take-profit orders.
• A stop-loss (SL) order is an instruction for brokers to automatically exit a certain position once the SL level reaches the market. This automation makes SL order ideal for traders who can’t actively monitor their open positions.
• A trailing stop order is another type of SL order. The main difference is that a trailing stop order follows the market price as it goes up. This provides traders with opportunities to lock in profit while being protected from market risk.

Types of Forex Orders

When you're on the forex market, you can instruct your broker to execute a trade based on your criteria or preferred market level. 

Here are the common types of forex orders you can use. Remember, the availability of these orders varies depending on your broker.  

Some brokers may offer all these, while some don't. It may also depend on the trading account type you have. Most of the time, only expensive trading accounts can access sophisticated forex orders. 

Market Order 

Market orders are the most common forex order types because all trading platforms have these orders. Well, without these, it'll be impossible for you to access the market manually.   

These orders immediately execute your trade right after you place the order. This way, you set your trade at the current price level with minimal slippage. Essentially, this forex order is ideal because you ensure that you enter a buy position at the lowest possible price and sell it at the highest price possible. 

There are two types of market orders: 

1. Buy order: A market order to buy or go long on a position.  
2. Sell order: A market order to sell or go short on a position. 

Assume you checked MT4 to check the current price of EUR/USD. You noticed that the broker's bid price is 1.2200, and the ask price is 1.2202. With this, your buy market order would execute at 1.2200, and the sell market order would be placed at 1.2202.  

Limit Order 

Unlike a market order, limit order does not immediately execute your buy or sell order.  

Limit orders are best to use when you want to enter the market, but the current price is lower or higher than preferred. With limit orders, you ensure that your position is only (and will only be) executed when the market becomes favorable.  

Here, you place a buy limit order at the market price or put a sell limit order higher than the price. This instructs your broker to execute the trade automatically once the market has reached the limit order level.  

Assume you want to go long on the EUR/USD because you foresee that it will experience a market reversal. However, the current market price is 1.2000, and you want it at 1.1990.  

So, what should you do?  

Do you have to closely monitor the market and wait until it reaches your desired market price?  

While it's okay to do that, setting a limit order is more efficient. With limit order, you can place your order at any moment you deem best, leave your trading device, and have your broker execute your trade once the market meets your limit order.  

If after several hours and the market hasn't yet reached your limit order, you have the choice to cancel it or adjust it.  

Stop-Loss Order 

The stop-loss (SL) order is a type of forex order that mitigates your position potential 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 buy order, you place it below your entry point. Likewise, you place your stop-loss sell order above the market if you're entering a selling position.  

Assume you go short on EUR/USD at 1.1100. To limit losses, you set your SL buy order at 1.1080. With this, you instruct your broker that you're only willing to risk 20 pips for the said position.  

Note: What SL does is protect your position when the market moves against it.  

Take-Profit Order 

As the name suggests, the take-profit (TP) order tells your broker about your prospect profit for the specific position. When setting this up, you simply put the TP level above or below your entry point, representing the market level you want your position to close to lock in your profit.   

For buying position, you set your TP above the entry price. Meanwhile, if you're opening a selling position, you place your TP below your entry price.  

Suppose you're entering a buying position at EUR/USD, and you have a great analysis concluding that it will appreciate. However, you know that your emotions often get the best out of you. What you did is set a TP order.  

Since your entry price is at 1.2200 and you want to get at least 50 pips for this position, you set your buy TP order at 1.2250.  

Deeper Look at Stop-Loss Order 

"Forex market is volatile", "Market fluctuates all the time", "Beware! Market movement will surprise you." 

I'm pretty sure you've seen enough of these phrases everywhere when you're reading about forex trading. And pretty sure that you've got the impression of always watching the market- closely, efficiently.  

But what if you've got to do your day job? What if the market spikes SO hard within a second? Do you just accept that you're about to lose money and blow out your account? 

Absolutely, not. Setting a stop-loss order can be an effective risk management strategy to avoid losing your money rapidly and further. 

Why Use a Stop-Loss Order? 

It simply means that you have a trading plan if you set an SL order. Essentially, you have a predetermined price point for exiting a losing trade.  

With an SL order, you can have the peace of mind knowing that your losses won't be too big, which may damage your trading account.  

Advantages of Stop-Loss Order 

Aside from its importance in managing market risk and limiting losses, there are other advantages you may get when you set up an SL order.  

1. Emotional Control 

Traders and emotions should not come hand in hand in the financial market. If emotion overpowers your position, it's likely to experience substantial losses.  

But with an SL order, you have a predefined exit point if the market crashes against your position. Also, you're likely to stay disciplined and stick to their trading plan if you place an SL order. 

Another great thing about stop-loss orders is it frees up mental capacity and reduces stress associated with constantly monitoring your positions. With its automated feature, you can focus on other aspects of your life without being too occupied with the market worries.  

2. Protection Against News Releases 

News releases are one major thing that drives market fluctuation. If you fail to monitor or anticipate the market sentiment from these releases, your position may greatly suffer.  

Stop-loss orders provide protection in case of unexpected market events or sudden price movements due to major news announcements or economic data releases. These orders help mitigate the impact of adverse market movements that may lead in significant losses if the trade is left unmonitored. 

3. Automated Execution 

Not all traders have the privilege to monitor the market all the time. If you execute a trade, you need to either close it if you're going out or keep it and just hope that the market won't move against you.  

But setting an SL order saves you from that hassle. Stop-loss orders can be executed automatically by the broker's trading platform once the specified price level is reached.  

This automation removes the need for constant monitoring of the markets and allows you to manage your positions more efficiently.  

Stop-Loss Order vs. Trailing Stop Order 

Unlike stop-loss orders, where you input a specific price level, trailing stop uses a percentage that moves with the market's current price. This percentage must be below (if buying) or above (if selling) the market price to represent the profit loss you can take. 

Here, you're not relying merely on the price when you enter a position. The trailing stop follows the market price as it goes up. This way, you won't miss out on bigger gains when the security value increases. 

But don't worry, this feature safeguards your profit in case of market reversal. The trailing stop percentage won't follow the market movement when it experiences a downtrend after moving up. 

The trailing stop loss will remain on the last level before the price declines and will exit once the downtrend meets the trailing stop level.

For the next lesson, you'll explore the three important rules in using stop-loss orders.