The importance of a stop loss

Author: Forex Live | Category: Education

Why a stop loss is vital in trading

If traders do not wish to blow up their accounts, they need a stop loss. There are a number of reasons for using a stop loss.

However, some strategies can forgo a stop loss, although it is usually the realm of institutional traders to do things like that.

The Biggest Friend

The stop loss is a trader's biggest friend, as volatility in the currency markets can go up at any moment.

No one can predict a surprise announcement, some event halfway across the world, or worse, something goes on while traders are asleep. Thus, the stop loss is every trader's guardian angels. In the forex markets, there is a multitude of reasons they could see a sudden spike in price.

For instance, in the past few years, the Swiss National Bank defend the 1.20 level in the EUR/CHF pair.

But on January 15, 2005, the SNB unexpectedly abandoned the peg and let the market drop as they had been protecting that level for some years, and it had finally gotten too expensive. Huge amounts of institutional money were coming in and buying the pair every time it got near the 1.20 level because it was easy money. Then, as soon as the Swiss stepped away from the currency markets, the pair collapsed and declined some candles in milliseconds. Globally, there were stories of retail traders who had refused the common sense of putting a stop loss and became wiped out.

It's There for A Reason

Stop losses are not just there to protect traders' accounts against disaster; it also represents a 'line in the sand' as to where the analysis is proven incorrect. If it's incorrect, they exit the market and live to fight another day. However, too many traders are moving stop losses to avoid taking a loss, but the successful trader is willing to cut losses quickly.

In addition to that, a successful trader understands that if the analysis is proven incorrect, it's better to make the losses very small. But if the analysis becomes correct, moving the stop loss is in traders' favor to lock gains is a perfectly acceptable strategy. And this is enabling the marketplace to tell when it is time to get out after a large run higher.

Do Not Trade Without a Stop Loss

Whatever the situation is, never trade without a stop loss. There are far too many reasons traders could lose a massive amount of money. This is the best way to neutralize the account if the trade doesn't work out. Also, traders can use this as a way to gain profit if the market pulls back after a big move in their favor.

People who believed they were smarter than the market and careless to take a loss are everywhere in the forex world. A 100% successful strategy does not exist, other than limiting the losses and expanding the gains. Still, losses come regardless, so protecting the account is the only thing traders can do.

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