Traders in foreign exchange currency pairs are exposed to losses when markets do not follow predicted patterns. Currency markets are essentially volatile. Some traders work on a daily short term basis and are not willing to undertake long term investments which may carry greater risks but can potentially generate larger profits. Computerization and the online business have become great allies in the forex trade. Computers generate charts filled with valuable market data and can automatically reveal market trends.
Who is the successful forex trader?
The novice trader must be wary. Traders cannot be greedy for monetary profit but must work in a cold, calculating manner. The skills of trading take time to develop and experience is usually a story of highs and lows or a mixture of profits and losses. Predicting the rise and fall of currencies is the major concern. Trends may suddenly change due to disruptions in the normal way of life. Technical analysis procedures make detailed studies of past events in the history of hundreds of years of trade. The golden rules to remember are that history often repeats itself but past market patterns do not provide certainty of future market trends. Sudden changes in social and political situations or changes in banking policies and interest rates could impact market trends substantially.
What is Stop Loss?
Is there a method to protect against financial loss when the risk becomes excessive? All organizations maintain safety standards and policies like fire safety and disaster management exercises take place throughout the world and particularly in earthquake and flood prone areas like the Himalayas and Eastern India. Such policies prepare against possible emergencies through rigorous training and physical infrastructure. Financial markets too need a safeguard to protect against sudden market fluctuations because of certain factors like changes of government policy, new financial rules, festivals, wars and communal problems.
Traders protect their interests with the Stop Loss mechanism that may be achieved electronically according to certain settings online or even manually when the trader has to intervene. The anticipated trends based on which the trader had bought and sold currencies may not always turn out to be true as forecast. The Stop Loss protects against volatile changes that may go against the trader’s interests. A trader must set up boundaries just like playing games that always observe fixed boundaries.
Forex markets are prone to high leverage which means that gains can multiply and losses too. The stop and limit orders effectively shield investors against unforeseen risks like a safety valve. The stop order indicates the price at which the trader wishes to buy or sell. The limit order prescribes the minimum and maximum prices for buying or selling.
The crucial time factor
Let us consider the time element which is so much allied to the money question in modern times. Time being money is the common idea floated around everywhere especially in regard to business ventures. Day traders and Swing traders are short term investors depending upon the whims of the market regarding currency pairs. The time stop applies here like for the day trader who is not willing to take on the risks that may occur during the night. The day trader fixes the stop just outside the daily range of the currency pair invested upon. The investment is protected if the market were to move in a retrograde position. The swing trader places the stop loss outside twice or thrice the normal daily range. The position trader on the other hand holds long term investments of months or years and has planned the investment according to the favorable conditions that may exist. Social, political and economic events could impact the fortunes of the financial market and must be adequately prepared for if known in advance like bank announcements.
The purpose is to stop the trading when the market moves in the opposite direction that would be unprofitable to your investment. Markets are often unpredictable and one cannot be too sure of the outcomes. Stop losses protect against the unseen and the unknown. A lot of judgment would be required to impose effective stops. If losses recur, the stops were not properly made. The stops should not be too far out either since trading would be hit. Reasonable stops that may need periodic changes according to market demands may ensure adequate profits for the trader.
Three stop loss strategies
Though many kinds of stop loss policies exist, three common methods are as follows:
Equity stop is the wise policy when the trader is not familiar with technical analysis. The stop is placed based on the money factor. Such a policy does not require stops to be often changed and peace of mind exists because loss cannot extend beyond the set limit. In other words, the trader is capable of undergoing a certain amount of loss. The trader may decide upon a certain limit to the loss according to a percentage of the investment and impose the stop accordingly. As an example, the trader may be willing to undergo one percent of loss and fixes the pips accordingly.
Technical stop: Technical indicators often provide the basis for entry and exit. Moving average crossovers may provide the basis for investing and consequently the time to exit would be when the moving averages cross again in the pair of currencies. Support and resistance levels are determined by such moving averages besides other indicators like Fibonacci. Psychological levels are also used to place stops. Trailing stops mean that the stop is dependent upon the movement of the currency pair.
Volatility stop: The instability of currency pairs may vary during a day’s trading, some currency pairs being more volatile. While the euro versus the pound is 90 pips, the pound versus yen is 255 pips. Study of the Average True Range helps to decide where the stop needs to be placed. Smaller ATRs would require closer stops while higher ATRs would be suitable for wide stops. The day’s price chart also helps to understand the swings of the currency values.
The ideal trading strategy
The perfect trader may not exist since every trader’s story is a series of profits and losses. The novice trader needs to make short term investments and carefully plan the stops to avoid losses. A logical approach and avoiding greed for money is recommended. Such stops are easily done in a world of computerization and manual stops may be sometimes necessary.