What Is A Stop Loss And Why We Need One?
When the price reaches a predetermined level, our trade is automatically closed with a Stop Loss order. We typically have the option of entering our stop loss level when opening an order.
There are two kinds: if we place a sell order, we must set a stop loss some distance above our entry price. When placing a buy order, we are required to set a stop loss some distance below our entry price. For instance, let’s say the EURUSD price is 1.22432 and we want to sell, so we set a stop loss of 20 pip. It is 1.22632, according to us.
By employing a stop loss in this manner, we can only put our total trading capital—typically between 1% and 5%—at risk per trade. What’s more, consequently likewise restricting the misfortunes for us which puts our psyches very still while exchanging. Psychology, or, to put it another way, how you react to that price when it triggers your signal, is the most crucial aspect of trading. Or to put it another way, it will have an effect on how well you trade.
I typically take a risk of around 20 pips per trade. This indicates that in order for me to feel comfortable placing that trade, I would need a total bank of £400 and a risk of £20 if I were trading at £1 per pip. If I were to risk more than that, I wouldn’t feel comfortable, and if I don’t feel comfortable, my trading will be affected. For instance I could waver and get in late, or on the other hand on the off chance that I see benefit however I’m frightened I could take benefit yet this could choke out a great exchange. Therefore, as we are aware, setting a stop loss at a level with which you are comfortable is very important for your psychological well-being, which in turn will influence your trading decisions and performance. like any other sport, for that matter.
“A true professional trader doesn’t care if he wins or loses” is a phrase I’ve heard a lot. Well this is valid on the grounds that he knows his technique for exchanging will likely get benefit over the long haul. The ratio of the trades we win to those we lose is what matters, and this ratio will only become clear over time. If you’re a true professional, it doesn’t matter if you win or lose on a particular day because of this. When we lose repeatedly over many months, we know we are not doing well and need to reevaluate our strategy.
However, if you want your system to make money, you can’t rely solely on stop loss strategies!
I’m sure there is a lot of debate about exactly how to use a stop, and I’m sure there are more books and websites that cover this topic in great detail. However, in my opinion, a true long-term profitable trading system does require a stop loss, which is very important. It shouldn’t rely on a stop-loss strategy because I’m sure it won’t work long-term because, when things go wrong, these kinds of systems typically wipe out your entire capital.
If a trading system relies on the stop method, which I believe is not the way to long-term profitable trading, then it must consistently get the direction right. Let’s use Roulette as an illustration. Although I enjoy playing online roulette, I can tell you from personal experience that no strategy can beat the game. Over 7000 roulette systems are available, according to what I’ve heard. There will be variants of each of them that use the Martingale betting strategy. Let me explain briefly:
Martingale basically aims to double the next bet to make up for a loss. The temptation is strong, which is fair because it seems like you can’t lose, but you can. You can see that the player’s risk capital will eventually be destroyed by a prolonged losing streak. If you look at the roulette player over a long period of time, it will appear that they are doing well, but if you look at how long they have been playing, it is very likely that they have at some point lost all of their risk capital.
Balance £100 Bet £1 on Red it Loses Bet £2 on Red it Wins Bet £101 Bet £1 on Red it Loses Bet £102 Bet £1 on Red it Loses Bet £101 Bet £2 on Red it Loses Bet £99 Bet £4 on Red it Loses Bet £95 Bet £8 on Red it Loses Bet £87 Bet £16 on Red it Loses Bet £71 Bet £32 on Red it Loses Bet £39 Bet £64 on Red it Loses Bet £ simply because you are unable to obtain any information or advantage over a number. In the event that we do level wagering on Roulette, the gambling club edge will gradually reduce our equilibrium too. To make money here, you can only rely on luck.
Even though the stock market has some predictability, it is not fixed-odds betting, so the odds of the price moving in your favor or against you change constantly. Indeed it very well may be hard yet a decent situation can take care of business if not there would be no drawn out productive dealers which I can guarantee you there are.
I am aware of the most well-known methods for stopping losses:
This is where the stop level moves alongside the cost at a predefined level as set by the merchant. Let’s say, for instance, that we want to sell at 1.22432 and set our stop at 1.22632. Now, without the trader’s intervention, our stop will follow price and move to 1.22532 if it falls below 1.22332. Now, in the event that the price moves against us, the stop will remain at 1.22532, preventing us from incurring a larger loss than if we left it at 1.22632.
However, there are advantages and disadvantages to this method.
Pros: It reduces losses. Cons: It prevents your trade from breathing, which limits some potential positive moves.
In any case, everything relies upon the kind of framework you use. I think it’s fine if your system can anticipate breakouts.
Break Even: The stop loss is moved from the stop loss level to the entry price when the price moves in profit by a predetermined amount, safeguarding the trader from losses.
Let’s say, for instance, that we want to sell at 1.22432 and set our stop at 1.22632. When we are in profit by 20 pips and believe we should move our stop to break even. The stop is moved from 1.22632 to our entry level at 1.22432 when the price reaches 1.22232.
This kind of stop loss strategy works well for swing trading or when your system intends to hold the trade for a day in search of a good trend.
However, there are advantages and disadvantages to this method.
Pros: You can keep your trade for as long as you think the price will go your way.
Cons: The fact that the markets fluctuate occasionally can prevent you from making any profits.
It all depends on how the market behaves, and it believes that this method requires additional market analysis.
50% Lock In This strategy works best for holding a trade for a day or two and locking in half of what’s there because it first lets the trade breathe. It’s good because it follows the golden rule of keeping winners and lets our business breathe.
Normally, I would trade this as follows:
I would place a buy order for EURUSD at 1.22432 at 8 a.m., with a stop loss of 1.22232 at 20 pip. When I return at 12 p.m., I find that the price is now 1.23032, indicating a 60-pip profit. Therefore, I would adjust my stop to a 50% level at 1.22732 so that I can confirm that I made a profit regardless of the price’s movement and still have the opportunity to do so.
When we place a stop loss level in the opposite order, this is called a stop reversal. When you make a mistake in the trade, this is a good way to react. You would place a buy order on the EURUSD at 1.22432 with a 20-pip stop loss at 1.22232, and you would also place a sell order at this stop loss level of 1.22232 in the opposite direction.
My personal favorite is holding for days while stopping the major peaks. Even though you’re only risking 20 pips with my system, every three to four trades you make will result in profits of more than 100 pips because I use the 50% lock in with a slight difference. I consider the previous major price peaks and set my stop at these levels rather than locking in the 50% level. Because price peaks provide a better indication of the true direction of the market, using price peaks is the best way to maintain that direction. Even though prices fluctuate, if someone is shorting, for instance, the price shouldn’t rise above the previous peaks until there is a significant shift in direction.
What is your ideal risk-to-reward ratio and profit factor ratio?
I’ve seen a lot of trading systems, and while they all look great on paper, one thing they never show is that you have to figure it out for yourself. The Profit Factor Ratio, or PFR, is its name. The ratio of your profits to losses can be found here. Your system is profitable if, after many trades, it remains above 1. All trading systems fail to show you this crucial point, which is what you need to be a truly profitable trader.
I remember a particular system that, I suppose, stuck with me and inspired me to aim for maximum profits with minimal risk by holding a trade for a few days. I obviously cannot mention names here, but the main promise was that most trades would be profitable by lunchtime by more than 100 pips. Now, just like every system you read about, they always emphasize the good things while ignoring the bad ones. The actual operation of that system is not shown to you. After purchasing the system and trading with it yourself, you can only see the reality.
Therefore, we must conduct backtests to determine the system’s true PFR.
My trades typically have a risk-reward ratio of one to four, so if a trade wins, I expect a £4 return for every £1 I invest. The profit factor ratio is what really matters, not this statement. or merely your gains and losses. If it’s higher than 1, you’re making money. The speed at which we can profit and the amount of profit we can make are determined by how high above 1. So when I trade, I always check that my system is working and that my PFR is higher than 1.
Let’s say, for instance, that I placed 1000 trades with a strike rate of one in four and that each trade that won made £20, while each trade that lost made £5. We can anticipate 250 champs and 750 failures. At first, it sounds bad: 750 losers, Oh No! but keep an eye out for:
Our PFR is 1.33, which I would consider to be a realistic PFR. 250 winners at £20 per win equal £5000; 750 losers at £5 per loss equal £3750. If we trade at £1 per pip, we will make £1250 from every 1000 trades. A potential profit of £1250 from a £100 investment is significant. Naturally, this is a moderate PFR; there are numerous systems with higher PFRs. According to what I’ve read, the majority of systems can realistically get below 2.0. I can live with mine being 1.33.