By: Christopher Lewis
When trading the FX markets, it is absolutely vital that you know when to cut your losses. By being able to identify when it is time to get out of a trade, you can keep your losses small, which will in turn allow you to continue trading when the market behaves as you predict.
By being able to take losses when they are small, the leverage that you apply on a trade will not come back to bite you as hard and can keep the account well funded. When you do not learn to cover your losses, it can lead to devastating losses that you will not be able to recover from. In fact, this is one of the most common killers of forex trading accounts. But the biggest issue is to recognize when it is time to let go.
How to know when to stop:
There are several different methods that you can use in order to determine this, but they all have one similar component: acknowledging a specific point on the chart that represents when your analysis isn’t correct.
For some people, this is a percentage of their total account. As an example, you might decide that any time you are down 3%; you are going to get out of the market, no matter what is going on. This is very common, and allows you to have a specifically defined amount of loss you are willing to take.
Another very common method is to simply place a stop loss at a point that you feel represents that things are changing in the marketplace. For example, many traders will place their stop loss below the most recent swing low (in an uptrend) or the most recent significant swing high (in a down trend). By doing this, you are forcing the market to change recent trends in order to take you out. It proves to you that the market isn’t going where you thought it was, and you need to step back and rethink your position. By doing this, you can take yourself out of the emotion of the moment and begin to clearly see the opportunities that may or may not be there.
Some traders will simply base their exits on time. For example, day traders will not carry a balance over to the next day, and will exit the market no matter what at the end of their trading day. This allows them to highly leverage their trades and sleep at night without worry about spikes in the middle of the night going against them.
No matter what you decide to base your stop loss placement on, the common theme on all of these viable methods is that you have to be committed to adhering to their rules. Most traders that blow up their accounts all have the same issue: they broke some of their “golden rules”, and stop losses are without a doubt one of them. One of the most important points to remember is that the markets are always there, and the next trade is just around the corner. You can go ahead and admit that you were wrong in your analysis, and close the trade. Doing so will save you money in the long run.