When trading the financial markets, all traders must bear in mind what is called risk management. Financial market traders can get their accounts wiped out and lose their equity fast if they don’t adhere to the rules. Risk management rules include stop loss and take profit prices, as well as other capital preservation methods. Today we will focus on one of the most important, which is the stop loss.
Stop loss orders vary and can be based on different factors, not necessarily just the price. Stop loss orders are placed to protect accounts and open positions in case the market reverses against the trader and the positions incur a huge loss. So how to determine the best stop loss level for any specific trade? To place a stop loss traders must bear in mind several factors and then make a decision as to which stop loss is the most appropriate for this specific trade. These factors include technical levels, volatility, support and resistance levels, time frame, as well as the characteristics of the currency pair traded itself. Some different types of stop losses are:
1- Equity Stop
One of the ways to determine a stop loss price is the equity stop where a trader would decide to risk a certain amount of money or a percentage of his/her account on a specific trade. If the trade loses and the account falls below the specified level then the trade is closed and the loss is realized.
2 – Technical Stop
This is one of the most commonly used stop loss levels. Traders analyze the market technically and give a thorough look to support and resistance levels previously created in the market, whether caused by consolidation or a Fibonacci level, then place their stop loss orders around this level, bearing in mind the volatility of the traded pair.
3 – Volatility stop
Traders keep an eye also on the Volatility Index (VIX) to determine if the market conditions require an exit strategy to protect the account, such as on days when there is fear in the market, and thus violent price action.
4 – Event Stop loss
If a trader has a plan that is based on a certain scenario an unexpected event could take place which could have an influence on the trade. In this scenario, traders would decide the stop loss based on the specific event circumstance.
Stop losses are a method to protect traders’ accounts and almost always, it’s better to be stopped out from a trade rather than losing the entire account equity and fighting the market. As goes the famous trading golden rule, it’s better to stay alive and live to fight another day.