We often hear some statements that Stop Loss is an important part of any forex trader risk management strategy. However, the case for placing a stop loss is not as clear as it seems. Although it might be good to use stop-loss, there are some pros and cons that traders should think about. Thus, some traders prefer not to use it in their trading. On the other hand, many traders still use stop loss because of its advantages.
Check out the positive sides of using Stop-Loss:
Risk of a stop-loss limit
The idea behind stop loss is very simple. If your position is too far in the wrong direction, then a stop loss will generally guarantee to close your position after your loss reaches a certain amount. This is very important if you don’t monitor prices minute by minute. Accroding to Vladimir Ribakov, using a stop loss is very handy when it comes to mid-long term trading and trades that take more than a few minutes. Stop loss will execute automatically after your investment reaches a predetermined level of loss.
Avoid emotional decisions
In addition to the automatic nature of stop-loss, stop loss can also help you avoid making decisions that conflict with your overall trading strategy. When a position causes a loss, most forex traders will be very tempted to chase losses with an average down or hold on until the price recovers.
However, trends are a powerful driver in the market, so giving your emotions and trying to recover your losses is generally a bad idea. Placing a stop-loss will help you avoid this.
Short-term fluctuations
On the other hand, stop loss can change investments that have been obtained into losses. If you place a stop loss too close to the strike price for trading, then there is a good chance that normal volatility in the market will cause the stop-loss order to be triggered before you make your profit.
This can even happen if you are right about how prices will move in the medium term. Generally, you might want to place a stop loss at a level where short-term fluctuations might not trigger orders. That is why it is important to use indicators to measure market volatility when you place your stop loss.
Also, your stop loss placement depends on your forex trading style. For example, if you are a short-term trader, then you might want to place your stop loss so that you limit your potential losses to a few percents. On the other hand, if you are a long-term trader, then you might want to place your stop loss longer.
Holding positions overnight
One argument against stop loss is that prices may go down or go up overnight, and therefore your stop loss will protect you. However, you can also get guaranteed stop-loss. It means that if the market gap is overnight, your risk is limited.
This will burden you a little more when you trade, but it can definitely be worth under volatile market conditions. And the good news is that some brokers offer a guarantee to stop automatically every time you trade. This means you can be sure of your risks at any time.
Is stop loss harmful?
While stop loss is an effective risk management strategy, there is evidence that Stop Loss may have a negative impact. In fact, one analysis shows that overall trading performance is impaired by each stop loss placement – even if the stop loss is 50% of the opening price.
Thus, if you have good emotional control and can monitor your position in real-time, then stop loss might not be for you. However, if you are just an ordinary person like most of us, then it might be better to stick with a stop loss and manage your risk.
