Back to Basics – Determining Stop Loss

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In this article, I would again like to return to the basics of successful trading.

There is no better topic than stop loss topic. I had the opportunity to work with hundreds of new students from all over the world in our academy’s Forex classes. Every Forex trader who came to me, without exception, received the same instruction that it is vitally important to use a stop loss. I get goosebumps when I meet a trader who does not use stop loss to protect his capital while trading. Every time I ask them why they do this, the answer is usually the same: “If I use a stop loss, it can throw me out of a potentially profitable trade.” I perfectly understand the psychology behind such thoughts, as I myself thought the same in the early days of my trading career, however, from the very beginning we must recognize that stop loss is a trader’s best friend. One day the market will start moving against you all the time, and then what will you do? When used correctly, stop loss will protect you from such situations.

Over and over again, I declare that consistently profitable trading is not about frequent wins and big capital gains on every trade. It is undeniable that having a streak will help you maintain an account in the event of a streak of losses, but ultimately the professional trader strives to be the best at risk management, which he or she can always do. In previous articles I have told you how any trader can still be profitable with more losing trades than winning ones. The one-of-a-kind action is making money with a low win rate, simply by cutting losses while they are still small and letting the profits grow. The most effective way to achieve this result is to use a stop loss order to exit the trade when you are wrong. It’s a capital preservation game, nothing more, nothing less. You only need to risk a small percentage of the trading account, on average it is 1-2%. To avoid the worst case scenario, we must place a physical stop loss to protect our capital. In fact, by placing the stop loss in the system (not in the mind!), The trader makes it imperative for himself to accept a small loss when the trade is wrong and he exits. It is the most disciplined action we can take in our trading career and a habit that will ultimately give us a real chance of success. when the trade is wrong and he gets out of it. It is the most disciplined action we can take in our trading career and a habit that will ultimately give us a real chance of success. when the trade is wrong and he gets out of it. It is the most disciplined action we can take in our trading career and a habit that will ultimately give us a real chance of success.

My approach to the market and trade detection is simple. When trading Forex, I look at the chart and try to find only the least risky entries that provide the greatest potential reward. It is not a problem for me to make mistakes several times in order to find the next day a position on the right side of the market and allow it to grow as long as possible. The only way for me to get an edge is to ensure that I buy the pair as cheaply as possible or sell it at a high price. I do this by looking at the areas on the charts where there has been the greatest imbalance between supply and demand in the past, and I use these areas in my trading. As you all know, if supply exceeds demand, then the price should go down, therefore, if demand exceeds supply, then the price should go up. Understanding this fact makes our job much easier, as traders limit themselves to only the highest trading probabilities. For example, take the graph below:

In this two-hour AUDUSD chart, we can see a rapid rise in price towards an area that was experiencing a large imbalance between buyers and sellers early on. Sellers won, forcing the price to decline rapidly from the delivery area, around 0.9050. With this area highlighted on my chart, I decided to place a pending sell order and place my stop loss, to protect the account, 10 pips above the 0.9070 high. Later that day, this position of mine worked, and this is what happened:

As you can see above, the price started to move in my direction and then jerked up to the stop loss, knocking me out of the trade with a small loss. However, then the price began to fall again, crossing the 0.9000 area, which was actually my first profit target. Now, you might think that this trade was a severe blow to me, as the price rallied just 4 pips above my stop loss before starting to decline again, and perhaps you are right in thinking so. However, I have been doing this long enough to accept this result. This is something that sometimes happens in the market, but if you have a solid and disciplined trading plan, then you can learn to expect it. The worst thought in this situation is to try to jump into the trade again after the stop loss has been knocked out, because there will be many times, when the price will not go as in this example. You have to remind yourself that this is the nature of the game and if you cannot accept it, then do not trade.

I do not consider this trade to be unprofitable, even though I have lost money. I had a plan for my entry, targets and my stop loss, and the result is not important, as the trade will be considered successful, since it will do one of the things that I expected from it. I see my stop loss not only as a tool to protect my capital. It is the most important part of my trade, protecting me from low probability trades. If the odds add up to my favor, then the stop loss is less likely to hit, but that doesn’t mean it won’t hit from time to time. Whenever you win or when you lose, always stick to the plan and protect your account. Stop loss is both simple in nature and important for executing a trade, thus being our only true friend in the market.

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