- Stop-loss is a commonly used order in forex trading, helping traders close their positions and curb unexpected losses
- A stop-loss strategy helps traders control the emotional response to price swings
- Trailing stop-loss is a method that automatically moves stop-loss orders to secure a profit. It is more flexible than a fixed stop-loss order
- Trailing stops automatically track the price direction and do not need to be manually reset like the fixed stop-loss orders
- Trailing stop orders move in one direction but can be used to secure profits in both long and short positions
In this article, we will explore how to protect your assets and profits with stop-loss orders. We will focus on trailing stop orders, how a trailing stop order differs from a stop-loss order, how it can be used, and in what scenarios the trailing stop is best used. We will also touch on some of the misconceptions around trading so you can feel confident about your decision to start trading forex.
What are stop and stop-loss orders?
Firstly, it is worth explaining what stop and stop-loss orders are.
A stop order is a market order to buy or sell a security at a specified price. A stop-loss order is an instruction to close out the position if the trade moves against you by a certain amount.
Traders can protect their capital with different stop-loss orders, with fixed stop-loss and trailing stop-loss orders being the most common ones.
A fixed stop order is an order to sell or buy a security at a predetermined price. The stop price is the trigger point at which the stop order becomes active. Once set, this price stays the same until it is manually changed.
A trailing stop order is a more dynamic version of a fixed stop-loss order. It offers a way to automatically secure profits and limit losses if the market moves against you by a certain amount. This is a good way to keep most of your profits while limiting the downside of your investment.
Both fixed and trailing stop-loss orders are used to protect your investment from losses should the market move in the wrong direction. If you have ever felt like you need more protection for your assets, then this article will help clarify which type of stop-loss strategy might be right for your investments.
Why do traders need a stop-loss strategy?
A stop-loss strategy helps eliminate the emotional response to price swings.
When traders start to panic, they can buy or sell quickly in the hope of not losing money. Any number of events can trigger this emotional response, including news announcements about current political climates, natural disasters, economic bubbles or unfavourable price movements.
Psychology plays a crucial role in trading forex. Sometimes, traders find it is best if they remove themselves altogether from deciding on active positions.
A stop order helps you do just that—move away from the fire. It can close your position when it reaches a certain level as dictated by you. The stop is intended to protect you from further losses if the market moves against you by a certain amount. Traders can use stop orders when trading any asset class as long as their broker provides that order type for that market.
Stop-loss orders are the most common tools traders use to protect their assets. However, some stop-loss orders are more dynamic and flexible than others, such as trailing stop-loss.
What is a trailing stop order?
A trailing stop-loss order offers a way to secure profits automatically.
Essentially, a trailing stop is a modified stop order. You can set it at a certain number of points or pips away from the position’s current price. If the price goes up, you gain more profit. If it goes down, the trailing stop closes your position and lets you keep some of your profits.
Firing a profitable stop-loss at the beginning of trade is another difference between a fixed stop loss and a trailing stop. With fixed stop-loss, you can only secure that you do not lose most of your money. Trailing stop lets you execute a profitable way to remove yourself from further trading. If your position continues to move favourably, so will your stop-loss level.
How does a trailing stop work?
Trailing stop-loss moves in one direction.
For example, if you have a 100-point trailing stop-loss on a long position, then it will sell your stock if the price drops 100 points from its peak trading price after purchase.
A trailing stop only moves up once a new peak has been established. Once the trailing stop has moved up, it cannot move back down. It always keeps a point difference from the last peak. If the price moves in an unfavourable direction, your trailing stop activates and protects your profits.
A trailing stop is more flexible than a fixed stop-loss order because it automatically tracks the stock’s price direction and does not need to be manually reset like the fixed stop-loss.
Traders can use trailing stops in any asset class as long as their broker provides that order type for that market.
If you are trading on MetaTrader 4 as provided by Rakuten Securities Australia, your trailing stop order is active on your computer. As your broker does not have access to your trailing stops at all times, you should keep your connection open to secure the execution of your trailing stop-loss.
Assume you bought one lot (100,000 units) of AUD/USD at the price of 0.74640. By analysing prior price action, you can see that price can fluctuate 30 pips before it draws a clear uptrend. These price movements can help you find a pip difference for your trailing stop-loss. Setting a 20-pip trailing stop could be ineffective, as one minor pullback could activate a sell order. In the case of a 30-pip pullback, your trailing stop would sell your position before the market gets a chance to move in your favour. On the other hand, choosing a 100-pip trailing stop is too risky. Based on the recent trends you have discovered, you noticed the average pullback is about 25 pips, with bigger ones near 40 pips. From this, you conclude that a more reasonable trailing stop ranges from 45 to 50 pips. This gives your position enough room to capture profits and get out quickly if the price drops by more than 40 pips. Excessive drop signals that something more serious than a pullback could be at play. You could be facing a complete trend reversal. Starting with a 50-pip trailing stop, your broker executes a sell order if the price drops 51 pips below your purchase price. If the price never moves higher, your stop loss stays at 50 pips below 0.74640. If the price moves higher, your stop-loss level automatically moves higher and stays there until one of these two things happen. If the price drops, the trailing stop will close your position. This either captures profits or cuts back on losses. Alternatively, if the price continues to soar, the trailing stop will move higher and continue to climb until it eventually closes your position and secures your profits.
Setting up a trailing stop order on MT4
You can set up a trailing stop-loss on the MT4 platform with the following steps:
- Open a position on the trading platform
- Right-click on a stop-loss block of your new position
- Hold your mouse over the Trailing Stop option
- Select the number of points for your trailing stop-loss
- The S/L block should turn yellow, indicating an open trailing stop order
To execute this market order, you may be asked for a trailing stop value in points. Keep in mind; one pip equals ten points. If you want to add a ten-pip trailing stop loss, put 100 points down.
The bottom line
Trading forex can be a lucrative way to invest your capital. However, with all trading endeavours, there comes a certain level of risk traders have to be prepared to face. Therefore, having a stop-loss strategy is one of the essential tools traders would want to have to protect their assets and limit risk. Rakuten Securities Australia (RSA) offers a chance to trade without risking any of your capital. Discover a way to trade with real-time prices and zero downsides. Open your free demo account today.