One of the first lessons learned by a beginning trader involves the creation of stop-loss orders and their placement to protect the account from unexpected market fluctuations. The general wisdom among traders is that using an absolute, numerical stop-loss value where the maximum loss is about 2 percent of the account is a prudent choice. While it is effective, this way of setting up a stop-loss point is by no means the only way of minimizing losses of an account. Here we’ll take at a few alternative approaches to creating a stop-loss point as you trade forex online.
1. Technical Stop
A technical stop involves the placement of the order at a particular value of an indicator, or it conditioning on the emergence of a technical formation. For example, the trader may choose to liquidate a position when the RSI rises above 80. Or he can close his trade when a moving average crossover occurs. Technical stops cannot pinpoint the actual amount of loss that will have to be tolerated, and as such, it is not a good idea to use them without other precautions.
2. Fundamental Stop
In this case the stop-loss order is tied to a market event. This may be a statistical number, a statement by the authorities, or any kind of fundamental value as determined by the trader or analyst. To give an example, in a currency crisis, a trader may choose to liquidate his position only when the central bank impacted by the crisis is able to obtain external funding commitments to repair its balance sheet.
3. Volatility Stop
A good choice for conservative traders, the trader may simply choose to exit a position when forex or stock market volatility rises above a certain level. This may be used as a kind of safety mechanism to protect some traders from an overly volatile market environment where emotional pressures are stronger, and risks are higher.
4. Hybrid Stop
The hybrid stop is arguably the safest and most profitable of the above approaches. In this case the trader combines an absolute stop-loss order with an additional one chosen from the previous three. For example, the trader may set up his maximum loss at 3 percent, going a bit beyond what is the market consensus in such situations, but complement that with a technical stop. In this case, any of the two stop-loss orders, when realized, will terminate the position.
It is possible to derive other ways of placing the stop-loss order, but the options discussed here are sufficient for demonstrating our point. It is a good idea to compare forex brokers first on the basis of the flexibility of their stop-loss choices, as you decide which one of them is best for your trading. In time, you’ll make a habit, and make your decisions swiftly, without pondering for a long time. And that, of course, will be your trading style. But before reaching that point, it is crucial that you practice each of the available choices so that you have enough experience to form your preferences.