What is stop-loss in forex trading?

Stop-loss is one of the most commonly used order types in forex trading. When you place a stop-loss order with your broker, you essentially give an order at what price your position should be closed. This comes in handy if the market moves against your bet and your position turns loss-making.

When the exchange rate reaches your stop-loss level, the position will automatically close and losses will be deducted from your account.

Alternatively, you may use a stop-loss order to lock in a certain amount of profit. If you give a stop-loss level that is higher than the current exchange rate and your currency pair reaches that level, your position will be closed. This is called setting a take profit level. Why is this good? Because there is no guarantee that the exchange rate may not make a sudden U turn (markets are fickle) and instead of making a profit you may end up with a loss. Remember that bird in the hand? 

You have two ways to go about setting stop-loss orders. You can either open a stop-loss order with a predetermined stop-loss level (thus your position will have a stop-loss from the very beginning), or you can set a stop-loss level for an existing position that has been open for some time. 

When opening a position, your broker will most likely allow you to set a stop-loss then and there, alongside a take-profit level. You will need to set your desired stop-loss level at that point.
If you want to add a stop-loss to an existing position, you will need to find where you can modify/edit that position on the trading platform. Most brokers offer this feature to their clients. 

If you want to try setting up stop-loss orders in a trading environment, you will need to open a brokerage account. Pick any of the service providers in our top list of the best forex brokers to give currency trading a try. Most of these brokers offer a demo account where you can practice trading with virtual money, risk free. 

First and foremost to make sure you won’t wipe out your trading account. Markets can change in the blink of an eye and unless you are glued to your trading platform 24/7, you won’t be able to protect yourself from losing heavily on a sudden drop in prices. With a stop-loss, however, you will be able to limit your losses, which is crucial in becoming and staying profitable as a trader. 

In most cases, a typical trader will not have all day to sit in front of a screen and monitor a position, let alone multiple positions at once. If you trade on a smaller time frame (i.e. an hourly chart), things get even speedier. The slightest break, like taking lunch, could be enough for prices to start going in the opposite direction, and if you did not set a stop-loss level, you are left with an open negative position. 

You may argue that “prices could go back” so it’s not important to close that negative position. This is a perfectly natural mental reaction but it won’t always do you good. In trading, this is called getting stuck in a position. There is no guarantee that the price will go back where you want it to be, what’s more, it may continue falling, multiplying your losses. The bigger the deficit on a position, the less you will want to realize the loss by closing it and you’ll be stuck in a downward spiral. Using a stop-loss can defend you from that.

Risk management is one of the most important factors of any trading strategy and it is the gatekeeper to being profitable.

There is a general rule in trading that you should not risk more than 2% of your account balance on a single trade. The newer you are to trading, the lower that percentage should be. Of course, if you are willing to take a higher risk, you can go further.

Given that you will have several positions open at the same time and you have limited time to spend on trading, managing all of them manually is nearly impossible. That is why you need stop-loss to take care of that for you. You can set precise stop-loss levels for each position to allow only a 2% loss of your account balance (on a $1000 account you would risk $20 on each trade).

We at BrokerChooser encourage every trader to make stop-loss a part of their strategy.

The main disadvantage of stop-loss is that short-term fluctuations in prices will close out your position and there’s nothing you can do about that. Regardless whether the price barely hits your stop-loss level and bounces back, a stop-loss order will close your position nonetheless. If that happens to you often, you may want to reconsider how you set your stop-loss level. The trick here is to learn setting stop-loss levels that still allow for a certain fluctuation while also limiting your risk. This will take some practice.

Using ATR (Average True Range) can also help with setting proper stop-loss levels. The ATR is a technical indicator that tells you the average movement of a currency pair, so you will have an idea how volatile it is. You can use the ATR to set rules that fit your trading style, e.g. stop-loss level should be at least 2x ATR away from the opening price so that daily/hourly changes in the exchange rate - depending on your trading timeframe - won’t trigger your stop-loss.

Sometimes your stop-loss orders will still do you wrong, and close a position that would have gone back in the right direction after popping your stop-loss level. Even if this happens, you should consider the cases when stop-loss saved you from potentially catastrophic losses.

One more thing to remember: even though a stop-loss will trigger the closing of a position, the actual closing price might differ from what you set previously if you are trading in an illiquid market. However, it is still a better protection than nothing at all.

Should I use stop-loss in forex trading?

In short, yes. Stop-loss orders are a key component of risk management. Without proper risk management, you do not have a complete trading strategy and you have a slim chance of staying profitable as a trader.

What is the best stop-loss in forex?

Each trader’s strategy should have its own rules for setting stop-loss, but as a general rule, it is advisable not to risk more than 2% of your account balance per position. In addition, the market situation should also be considered when setting a stop-loss level. Study the price chart before setting your stop-loss level and make sure it’s realistic. You won’t be able to force your desired stop-loss level onto the market.

Do professionals use stop-loss?

Stop-loss is generally used by all traders, professional or retail. It is a basic tool you need for your trading strategy regardless whether you are a newbie or an experienced trader.