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How to prevent premature stop loss


Mar.21.2014

Have you ever been correct with your trading strategy, but got kicked out of your market position because your stop-loss level was just a tiny bit overdue? If so, today's "Q&A Friday" is for you! We have covered a solution to the frustration of premature stop losses, as well as risk management and trade size calculation techniques. Don't forget to scroll down and watch both videos!

Question

Here is what one of our Invest Diva graduates, Adebimpe Adenrele, writes:

“Hi Kiana,

First, I'd like to say what a great job you're doing!!!!! I too am a female engineer (Aerospace Engineer) and pilot. It's always great to see other women in male dominated industries with style and brains!!!!!!  I have a little problem. I have enrolled in your education program and studied all your lessons twice. I usually have winning trades, but for a lot of them, I put the stop loss too close to my entry order.  I usually put about 5% on every trade and try and go for at least 1: 2 risk/reward ratio. I usually have a set 40 pip stop loss or 50 pip stop loss and adjust leverage to fit into the 5% risk.  I hold my positions for as long as it takes to meet the 1:2 risk reward and try not to tamper with it. It’s so frustrating to be right with your analysis, and then being stopped out because the stop loss wasn't 5 or 10 pips longer. Please help.

Adebi.”

1 Kiana Danial Invest Diva

Answer

This is a very common problem that you are having. I’m so proud of your for calculating your risk/ reward ratio carefully and taking a risk-averse approach to trading.

In all forms of long-term and short-term trading, deciding the appropriate time to exit a position is just as important as determining the best time to enter into your position. Entering a position is less emotional than exiting it, and at the end of the day, its your exit strategy that determines your total profit. Some traders are tempted to ride the tide a little longer, or in the unthinkable case of the market going against you, your heart tells you to hold tight and wait until your losses reverse. That is why setting a stop-loss and limit order prior to entering a position is very important, and I’m glad that you are doing it already based on your risk tolerance. But the markets can sometimes get too volatile temporarily, which can result in a premature automatic exit. To avoid getting kicked out of your trades prematurely, the best way is to follow up with the market sentiment and keep up with the economic news. While I don't suggest changing your profit limit order, you can adjust your stop-loss by monitoring how fast the market is moving against you. Only if you are confident with your position and have solid confirmation based on the fundamental and technical analysis, and believe the market will eventually change direction to your favor, then you can loosen up your stop-loss level. To measure the market sentiment, its best to switch into anywhere between the 1-minute, to hourly charts every once in a while.

Another basic technique for establishing an appropriate exit point is the trailing-stop method. the trailing stop simply maintains a stop-loss order at a precise percentage below the market price in your long position (or above it, if you have a short position). The stop-loss order is automatically adjusted continually based on fluctuations in the market price, always maintaining the same percentage below (or above) the market price. You can then relax and know the exact minimum profit that your position will gain. But before that, You must make sure that you are Setting your trailing-stop based on precise risk tolerance calculations and not based on emotions.
Also keep in mind that This technique requires the patience to wait for the first quarter of a move which means a number of candles on your trading chart before setting your stops.

How Not to Be a Loser in Forex Trading

Every investment carries different levels of risk and this remains true to trading currencies on the foreign exchange market (forex.)

One of the main risks in forex trading is unpredicted currency movements. Just like the stocks market, the currency market sometimes moves in an opposite direction from what you expected. That can result in losing the money invested in the market.

The best way to combat this risk is setting stop and limit orders. This means simply “ordering” your broker to fulfill your trade at a specific price and to get you out of the trade if you are losing more than you can afford.

As in any other market, you make money in forex by buying one currency low against another currency and selling it high against the same currency. Since the currency pairs can easily moves 100s of pips per day you first need to develop a trading strategy by following the fundamental market updates, technical analysis and market sentiment on websites such as InvestDiva.com. Once you are confident with your analysis, you can go ahead on your forex broker’s platform to place your order. But wait; don’t click on the “place order” button too fast! A responsible trader would first click on the “Advanced” button, where he/she can find the option of setting a stop or a limit order. Obviously we advise you to use both to ensure a more profitable and less risky investment.

Limit order automatically executes your trade when the currency pair reaches the particular price at which you wish to take profit.

Stop order order automatically closes your position if the currency pair moves against you by an amount that exceeds the amount of your risk appetite.

If you are entering a buy position (going long), your stop order should be smaller than the price at which you enter the trade. Your limit order should be larger.

If you are entering a sell position (going short), your stop order should be larger than the current price. Your limit order should be smaller.

The next big risk in forex trading is leverage, a double-edged sword which enables you to multiply your profit while it also multiplies your losses. If you are 100% confident in your trade, you may set a high leverage to expand your return, but by doing this you should know that you are equally expanding the risk of losing all your money. Leverage can be higher in the forex market than other markets therefore a more calculated risk management is necessary.

When you start trading in a real account, you usually start with investing a small amount of money. Some brokers even let you open accounts with just $50. Here is where you want to be careful, because trading a small account with a large leverage, if not done carefully and not followed by calculated risk management methods, can contain a huge amount of risk.

Leverage is a borrowed money provided by your broker which gives you the ability to control a large amount of money using none or very little of your own money.

Here is how you can best calculate your risk appetite on a leveraged market:

 

Many analysts advise that your risk per trade should always be a small percentage of your total capital. A good starting percentage could be 2 percent of your available trading capital. For example, if you have $5,000 in your account, the maximum loss allowable should be no more than $100.

Managing risk per trade literally means calculating your stop and limit orders, which we talked about previously. In order to decide the size of your trade`s allowable risk, advisable leverage, and so on, you can simply use the following Invest Diva formula:

Loss (or profit)/pips (stop or take profit) = size

Let’s say you have done all your market analysis, and you are confident that the markets are going to move in a certain direction for a certain number of pips. Now you have two options:

  1. Choose your trade size based on the profit you think you can make.
  2. Choose your trade size based on the loss you can afford to risk.

Choosing your trade size based on the possible profit is how traders with high risk-appetite usually trade, especially ones who are more goal-oriented and challenge the market to win.

Which of these choices do you think Invest Diva would recommend? If you said number two, you are spot on. Although it may sound a bit negative, it’s always better to be safe than sorry. With this trading strategy, you should first calculate the size of your trade by simply putting the numbers into the following formula:

 risk loss pip calculation stop loss entry order trade size

You can also put in any two of the three terms to get the third. In case you don’t have enough money to cover for the size, then you can move on to using leverage, keeping in mind that you may lose the exact same amount. Therefore, you need to feel comfortable with investing that amount of money.

Thank you Adebi for submitting your question and if you have a burning investing question you need to be answered, hop on Invest Diva community and ask away.

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