Forex stop loss strategy

Forex stop loss strategy

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Updated: Aug 24, 2022
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Intermediate
15 min read

No trader can survive in Forex without properly managing their money and risks. Luckily, stop loss orders exist for this purpose. Thanks to this class of orders, you can protect your positions and in general, your trading, since they eliminate negative emotions such as greed and fear, along with the consequences they leave behind. You may already know that a stop loss is a kind of order that allows you to get rid of a currency pair when it reaches a particular price. These types of positions aim to reduce losses. It goes without saying that stop losses are a great tool for when you can’t be in front of the computer to monitor positions on your own.

There are different ways to implement stop losses. For this reason, it is very important that you develop a Forex stop loss strategy that suits your needs. In this article we will explain how to develop a strategy to reduce your risks and maximize your profits.

I. Stop loss strategy: inside bar and pin bar

Next, we will talk about some strategies with inside bars and pin bars, so it is important that you know what these patterns are about. Where you set your stop loss depends on your strategy, although there are certain recommendations that are worth following.

First of all, we will deal with the pin bar strategy. In this case, you should set the stop loss below or above the shadow of the candlestick. That way, if the price hits the stop loss, the entire pin bar pattern is invalidated. Do not forget that there is nothing wrong with the price touching the stop loss. It is just the market telling you that the pattern was not strong enough.

On the other hand, the inside bar Forex stop loss strategy has two places where you can set the stop loss. One of them is below or above the high or low point of the inside bar. The second is above or below the high or low point of the mother bar. The most common (and safest) place is on the mother bar. As in the previous case, if the price touches the stop loss, the entire pattern is invalidated.

The mother bar is safer to set the stop loss because it is further away from the market entry point. This applies particularly to volatile pairs, as this way the stop loss is not triggered prematurely.

The second place of the stop loss (below or above the high or low point of the inside bar) provides a better risk/reward ratio. However, it has the disadvantage of being activated before the pattern develops properly. Therefore, it is the riskiest approach to this Forex stop loss strategy as there is less space between the stop loss and the entry point.

The method you choose to set your stop loss depends on your risk tolerance, risk/reward ratio, and currency pairs you trade. Now that you know where these orders are set, let’s take a closer look at other strategies that you can apply as soon as prices start moving in the direction you expect.

Stop loss strategy: inside bar and pin bar

II. “Set and Forget” or “No Hands” Stop Loss Strategies

Another good stop loss strategy is “set and forget”, also known as “no hands”. The idea behind this method is quite simple: set a stop loss and let the market go its way. Let’s see what the advantages are.

The “set and forget” stop loss trading strategy prevents stop losses from triggering too soon by setting them at a safe distance. This method also serves to take the emotion out of trading as you don’t have to intervene after setting it up. As soon as you open your position and set your stop loss, you just have to let the market take its course. Another advantage of this strategy is that it is easy to implement and only requires one action at a time.

However, “set and forget” has its drawbacks. The biggest of them all (and often the most expensive) is the risk present from beginning to end of the position. You must not forget that, at all times, there is the possibility of losing money. The second disadvantage is that you may be tempted to modify the stop loss. This can be a problem that can attack even the most experienced traders. Therefore, “set and forget” may not be the best Forex stop loss strategy, although it does have advantages that deserve your attention.

III. 50% stop loss strategy

This strategy aims to cut your risks in half (although not necessarily). The advantage of this method is that it is the market itself that indicates how much capital can be protected.

You can use the 50% strategy in a pin bar pattern. For example, imagine you find a bullish pin bar on the 1-day timeframe and decide to enter the market. The next day, the market closes at a price higher than your entry point. In this case, instead of closing the order or letting it break even, you can use the low point of the previous day to set your stop loss. Similarly, the next day, you would move the stop loss to the low point of the previous day. That way you can reduce your risk to more than 50% by taking advantage of the price action. However, if the market moves in the opposite direction, you will want to not be in the position.

Let us see some advantages of this Forex stop loss strategy. The first and most important is that it serves to reduce the risk by half. For example, if you are risking $100 on a position, you can move the stop loss and only risk $50 as soon as prices start to move in the direction you expect.

Additionally, since the 50% strategy uses the concept of price action, there is less opportunity for the market to hit the stop loss. This is because you are using the high and low price points to set the order, rather than a totally arbitrary point. Another thing in favor of the 50% stop loss strategy is that it leaves room for price fluctuations. That way, the market can move a bit without triggering the stop loss.

However, this strategy is not perfect, as it leaves 50% of the position at risk. This may be satisfying for some, but unpleasant for others. Therefore, it is your personal preferences that decide the type of approach you will use. Even though the 50% strategy offers enough room for prices to fluctuate, there is a chance that the stop loss will trigger prematurely. This is especially true for more volatile currency pairs, such as those that include the JPY.

Market conditions also play a big role in deciding if this Forex stop loss strategy is right for you. For example, if the market closes at similar levels two days in a row, the strategy will not work because you would have to move the stop loss too close to the market price. In this situation, the most appropriate thing would be not to modify the stop loss. Similarly, this method works better with the pin bar pattern than with inside bars.

There is only one way this stop loss trading strategy can work with the inside bar pattern: when the stop loss is set above or below the high or low point of the parent bar. In this case, after the second day, the stop loss can be moved to the high or low point of the inside bar (provided market conditions are correct). This method also serves to mitigate risks by around 50%.

IV. Forex trading strategy without stop loss

Stop losses are one of the tools in the arsenal of the most successful Forex traders. These kinds of orders commonly serve to protect trading accounts from market movements. However, some people claim that they can make money on Forex without Stop loss. Before we get started, it’s worth remembering what a stop loss is. These are orders that serve to sell a financial asset when it reaches a certain price, and are intended to mitigate losses.

Stop losses are said to take the effect of emotions out of trading decisions and process, as well as being especially useful for when the trader cannot constantly monitor their positions.

Although most believe that stop losses are vital to being successful in Forex, some believe the opposite and have actually found some downsides. This last group of investors use Forex strategies without stop loss. For this reason, in this article we will explore the advantages and disadvantages of using stop losses, as well as discuss how to trade without them and show examples of basic strategies without stop loss.

Advantages of using stop loss

The first advantage of stop losses is that they cost nothing to set, as commissions are charged only if they are triggered by the market. It can be said that this kind of order is like a free insurance policy.

Another advantage is that it is possible to make decisions in a totally rational way. Traders sometimes incorrectly believe that prices will move in their favor, so they trade Forex with no stop loss. Needless to say, the results are often disastrous. Stop losses can protect you and your trading account from these mistakes.

Also, thanks to stop losses, there is no need to constantly monitor the markets. These orders can prevent undesirable losses when traders are taking a break from trading.

In any case, you have to trust your strategy and strictly follow your trading plan. Stop losses do not guarantee any kind of profit, so you must make good investment decisions. In Forex there is no holy grail; you have to maintain control of your operations.

Forex strategies without stop loss

Disadvantages of using stop loss

Why do some traders disagree with stop losses? Before discussing Forex no stop loss strategies, let us consider a few points.

Under normal conditions, stop losses work without problems. For example, if you bought a stock at $50 and set a stop loss at $47.5, you would be capping your loss at 5%.

However, in a volatile market, price gaps are possible. This means that the stop loss will be activated, but not at the price you set, but at one that can vary significantly. Similarly, the market may exhibit short-term fluctuations that may incorrectly trigger the stop loss.

The solution is to choose a stop loss that gives the market room to fluctuate, while mitigating risks as much as possible. For example, it is not a good idea to set a 5% stop loss on a currency pair with a historical move of 10% or more in a week. You will most likely lose money in commissions when the stop loss is executed.

Another common problem with stop losses is that they are not always as transparent as you might think. Some market maker brokers like to lower the price of currency pairs to massively hit their clients’ stop losses. After this, the price changes direction.

The last downside is that with stop losses you hand over control of your positions to the system, which can cost you money in volatile markets.

For all these reasons, there are people who believe that trading Forex without stop loss is a better alternative. However, it is up to you to decide whether or not to use these kinds of commands.

Forex strategies without stop loss

To successfully trade Forex, you need to have an effective money management strategy. For such purpose, many traders choose to use stop loss. However, these are not always effective and are sometimes a cause for failure (especially when set too tightly).

There are Forex strategies without stop loss that you can apply if you do not want to use this kind of orders. Next, we will give you the necessary information so that you can decide if this style of trading suits your needs.

The Forex market shares some similarities with stocks. However, despite the similarities, few forex traders use proven working stock strategies (such as “buy and hold”). To consistently make money in the forex market, it is advisable to buy stocks and hold them until the fundamentals change. Similarly, good Forex traders do not open positions based solely on technical analysis, but rather consider economic, financial and tax factors in making trading decisions.

Forex sin stop loss

An important rule when applying a Forex no stop loss strategy is to follow the trend. It is no surprise that the long-term trend of a currency pair is usually determined by the economic and geopolitical factors of the countries involved. These factors usually include interest rates, balance of payments figures, and general government policies. If a nation’s economy is looking good and there are no aggravating circumstances, its currency is likely to appreciate. This is a standard principle.

With this kind of fundamental analysis, you can take a long-term view of currencies and prevent the small losses that you would have if you used tight stop losses. At this point, all you have to do is stay on top of pullbacks. In these cases, you can take more floating losses than you would if you used leverage.

However, this rule has some exceptions. If a price correction is approaching, it is a good idea to take small losses and reverse positions to take advantage of the change in trend.

It is important to use profit protection strategies if you decide to trade Forex without a stop loss.

In addition to avoiding losses, stop losses also serve to protect profits. An example of this is the trailing stop, which can be used to secure floating profits. The best way to apply this kind of order is to wait for a position to get a good amount of floating pips. In this case, you can set a trailing stop between the entry point and the current market price. This way you will still earn profits if the market moves in a positive direction, but you will avoid losses in the event that prices reverse. Similarly, there are limit orders that close part of a position when there are price reversals, even if the market has not reached the target profit of the operation.

To avoid large losses, many Forex traders choose to use tight stop losses. However, this approach usually results in a lot of small losses that can add up to a huge sum and wipe out a trading account.

Are you wondering if it is possible to trade Forex profitably without stop loss? Maybe. For such a strategy to work, though, you need to trade only in the direction of the trend, not over-leverage, and go long on traditionally strong currency pairs (i.e. as if they were stocks). Even so, the “buy and hold” strategy used in stocks is not very popular with foreign exchange investors.

V. conclusion

It is highly recommended that you use stop losses. Learn how to accurately determine levels to place these orders, use price action strategies and find an appropriate risk/reward ratio. A good stop loss strategy is the key to improving your profitability in the market. Therefore, you have to find the best stop loss strategy for you.


Sources & references
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James Knight
Editor of Education
James is a lead content editor for Invezz. He's an avid trader and golfer, who spends an inordinate amount of time watching Leicester City and the… read more.

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