Forex: Trading With The Stop Loss And Trailing Stop

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There are various risk management tools available to the trader in the foreign exchange (FOREX) market. Two of the most common ones are the stop loss and the trailing stop. What are they and what are they used for? Are they necessary for successful trading? This article will help you to understand these concepts and provide answers to these questions.

What Is A Stop Loss?
The platforms provided by many online FOREX brokers contain built-in features such as the stop loss and the trailing stop to help manage certain risks inherent in trading. A stop loss is a feature which allows the trader to pre-determine the price level at which the position will be automatically closed should the market move unfavorably against the open position. The primary benefit of the stop loss is to put a cap on the amount of loss a trader is willing to suffer. A well-placed stop loss is an essential component of an effective trading strategy. There are, however, traders who trade without a stop loss or trade with the stop loss set improperly. Both of these approaches are courting disaster.

Setting The Stop Loss
Day traders will typically have a different approach to setting a stop loss than those who take long-term positions. Because they are more interested in making quick profits resulting from small market movements, the day traders will typically utilize a smaller stop loss. In contrast, the wider stop is favored by long-term traders who are less concerned with the smaller moves of currency prices, including the temporary reversals present in the trend. Such price reversals would normally trigger the smaller stop loss of the short-term or day trader. Positions taken by long-term traders may be open for several days or longer, experiencing a fair number of reversals on the way to the take-profit target. Consequently, the wider stops would be preferable to this breed.

What Is A Trailing Stop?
A trailing stop is often utilized in connection with the stop loss. Indeed, it would be futile to attempt the trailing stop without first setting the stop loss. That is because the main purpose of the trailing stop is to move the stop loss incrementally in the direction of the profit target as the currency price moves way. Such has the effect of incrementally bagging profits while the position remains open. The original stop loss level cannot be reached by the price reversal without the trader?s position having first been closed automatically at the new stop loss level made possible by the trailing stop.

Setting the Trailing Stop
In a news trading situation?generally characterized by rapid price movement?a trader would ideally utilize the smallest incremental trailing stop allowed. The smaller the trailing stop, the more possibility there is for making and keeping pips without being subjected to the vagaries of whipsaws or other rapid reversals in currency price. As in the case of the stop loss itself, a smaller trailing stop would be favored by the short-term trader. For example, instead of waiting for the price to move 20 pips before the stop loss is moved and the 20-pip profit realized, the trader can realize profits earlier by setting the trailing stop at 10 pips, with the expectation of bagging 10 pips with each 10-pip move in the currency price. Although it would be a trader?s dream to have a trailing stop as low as 1 or 5, the lowest to be found on any broker?s platform is probably 10. Still, by utilizing a well-placed stop loss with the appropriate trailing stop, a trader can invest profitably and minimize the inevitable risks while preserving precious trading capital.

Sandy Robinson, J.D., Copyright 2007

By: Sandy Robinson, J.D.

If you are ready to change your future by stepping into the exciting world of trading FOREX, go to www.winningtradersassociation.com for more information. Author Sandy Robinson, J.D. is part of the Winning Traders Association, an educational organization founded by John Beiler, President. The organization consists of a network of committed trainers and motivated traders willing to provide support to those interested in trading foreign exchange. Many of the members work from home.

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