Hi traders, in the past weeks I spoke with some friends and a lot of them are talking about stop losses and the possibility of trading without stop loss.
Well, I wouldn’t encourage you to do that, as I personally is a firm believer of using stop loss to limit my risk exposures. Today I will show you a simple way of how I use stop loss in my trading.
Why are some traders trading without stop loss?
But before we go into that, let’s look at some of the arguments provided by the no-stop-loss camp:
Argument 1: “Stop losses” actually means “take losses”. They are there to make sure you take your losses before price eventually goes to you direction.
My opinion: If that happens too frequently for you, then the problem could be with your stop loss placement.
Are you putting stop losses too near your entry point? Have you backtested your stop loss trading plan enough? Are you consistent in how you place your stop loss, or is it just by guts feeling?
I strongly recommend you read my article on the importance of backtesting, if you have not done so.
Stop loss is a tool to help you limit your risk. You could use a knife to cut vegetables; you could also use it to cut yourself.
If it works against you, then it could be YOUR own fault as you could be misusing it.
“If you can’t swim, don’t blame it on your swimming trunks.”
Argument 2: I have the perfect trading system to hold my losing trade until it comes back to my entry price and eventually becomes a winner. In this way, my account will never take a loss.
My opinion: If you ask me whether price will come back to the entry point, I’m not sure.
Where will the price be tomorrow? I don’t know.
Will price be higher or lower tomorrow? I can’t tell.
Nobody in this world can guarantee whether price will come back or not, unless you have a fortune-teller trading system.
But there is one thing that I know for sure.
I know that prices will MOVE at least hundreds, if not thousands of pips away from the current price, given enough time. This is not a guess, not an assumption, but that is a fact.
Price moving away is inevitable. Just open any monthly chart and see it for yourself.
Now tell me, why would you want to bet against that? Can you withstand -8000 pips for every trade that went against you when you are trading without stop loss?
Argument 3: A stop loss can be easily hit by “stop hunting” activities conducted by big institutions. Therefore I am trading without stop loss to avoid getting triggered unnecessarily.
My opinion: Regarding stop-hunting, as far as I remember it does not happen frequently. And if it happens, it is usually during news or data releases, when there is a sudden surge in trading volatility.
Even though I am not that into news trading, I can tell you that you should not use your normal style of tight stop loss placement during such events.
Why is that so?
Because volatility is extremely high during news and events, and thus you will need to cater for a bigger allowance for prices to move up and down.
In any case, I do not encourage newbies to trade during news releases unless you’re feeling really rich. Especially if you are trading without stop loss.
But if you insist on trading these events, then just use a mental stop to manually exit a losing trade, and also place a stop loss order that is far away from the “battlefield” just for safety measures (just in case your forgot about your trade).
Using Stop Loss to limit your risk
Now let me show you how I use stop loss to limit my risk in my daily trading, in 2 simple steps:
Step 1) Knowing your reasons to enter that trade.
There should be a few reasons why you entered into a trade in the first place. For example, US unemployment rate showed bad data and EUR/USD bounced from a low of 1.1100 and price is now at 1.1150.
Therefore I entered a long EUR/USD trade at price 1.1150,
My reason for the trade: there is a good bullish momentum that resulted from bad US economy, and I believed that this bullish momentum will continue to carry my trade up to my target profit level.
Step 2) Knowing when those reasons are no longer valid
If price goes up in my favor, that will be great.
But if price fell and my timeframe candle closed below the low of 1.1100, then that tells me that my initial reason for entering this trade is no longer valid.
Recall that my reasons for entering this trade were due to strong bullish momentum coming from US unemployment data. However, when the price candle closes below the initial low, it would have completely smashed my expectations for this trade.
The right thing to do now is to bite the bullet and exit this trade manually with a small loss.
So where is the stop loss order?
I placed it at 1.1000, and that is 100 pips below the low.
So you see, I use stop loss order only as a safety net to limit my risk exposure, while I also use manual method to exit trades that no longer has a valid reason to stay alive.
The use of stop loss order is there to protect myself just in case of a sudden huge drop in price (which never happened to me before) and I never wait for them to get triggered.
Do not over-stay in a bad trade and hope that things will turn around.
The bottom line is, always be in control of your trades and remember why you entered the trades in the first place.
I hope my post today will help answer most of your questions regarding stop loss. For now I recommend that you read my article on the importance of backtesting, as I believe that will help you in defining your style for stop loss placement.