How Do Forex Traders Set A Stop Loss Level?
The following post has been added as I am constantly asked about stop losses and how to place them. Stop loss placement is one of the most difficult areas for many new Forex traders. The reality is that there is no perfect “one size fits all” solution to the question above. There are always going to be scenarios where the market takes you out by a few pips and subsequently continues in the desired direction. One thing we can do though is look at the current market conditions, and the price action, and set our stop losses accordingly. Lets take a look at a couple of support and resistance trade examples and the associated stop loss placement.
In the following example there are multiple swing lows and anyone looking to buy dips in the market would be looking for a logical level to set stop losses. If placing a stop loss under the previous swing low it could potentially have been hit and the trader would have taken a loss. The logical area to set the stop loss would be under the lowest low on this chart. The distance of the stop loss would be determined over the back testing/forward testing period on a Forex demo/trial account which can be opened with most brokers – see this easy forex review if you need help finding one. However, we may have chosen a stop loss level above the swing low if the back testing showed us that a break of the previous swing low would typically signal a failed trade and go on to take out the support zone. This is why we should document all of our trades and seek to improve the edge over a long period of time.
In this next example we will look at a pivot level with a very tight central pivot line. Unlike the previous trade, the pivot has been hit and subsequently rejected price more accurately on any support/resistance hit attempts. When the support line is broken and moves away from the level sufficiently a sell order has been placed for a retest entry. Price moves back to the level, opening the trade, and consolidates somewhat; even though the consolidation period is a bit choppy the level is only penetrated by a minimal amount of pips. In fact, if price had moved above this pivot by over 20 pips there is a good chance the area would be then seen as support on the lower timeframe. In the example below the stop loss was placed just above the consolidation highs which formed prior to the first reasonable move below the line. A tight stop loss here could have yielded a high risk reward trade.
There are many ways to place a stop loss but these example showed how support and resistance can be utilised in the decision making process.