Always use a Stop Loss
“There are bold traders and there are old traders, but there are no bold old traders…”
To be ‘bold’ is to not use a stop loss, and the quickest way to lose all your money in forex spread betting is to trade without using a stop loss. It’s a mistake that is repeated time and time again, mainly by newbie spread betters who think they can outsmart the market and never sustain a loss. But, as any ‘old’ trader will tell you, the most important element of forex spread betting is to protect your capital so you can live to fight another day in the markets.
What is a stop loss?
In forex spread betting, a stop loss is an automatic exit order you place with your broker (usually via their online trading software). You specify a price at which you want the trade to close to automatically, so that you can decide the maximum you are willing to lose on any one spread bet.
Eg. You think pound sterling will go up, so you buy at the market price of £1.5000, at £1 per pip. The most you are willing to lose on this trade is £50. So you place a stop loss at £1.4950, which is 50 pips below your buy price. If the trade goes in the wrong direction, your position will be automatically closed at £1.4950 and your loss will be £50.
Pros of a stop loss in forex spread betting:
- Allows you to walk away from from the trading screen knowing you will only lose ‘x’ amount of money if the trade goes wrong.
- Stops the emotion of fear and hope consuming rational decision making when a trade goes bad. Fear will prevent you from taking a small loss (eventually turning in to a massive one). Hope will convince you the trade will turn around and come back your way.
- Takes the decision making out of the trade once your in it, and keeps you stress free as you have truly accepted the risk for that one trade
- Demonstrates good planning and a strategic approach
- Allows you to calculate how many £s per pip you will bet, based on the where the stop loss is
- Stops you from wiping out your entire account in one go
Cons of a stop loss in forex spread betting:
- Being stopped out to quickly, just to see the trade eventually go your way (doh)!
- This is pretty much the only con of using a stop loss, but it’s something that is the trademark of a beginner, who doesn’t know where to place stops. With a little education, and lots of practice, it can be avoided.
Where to place your stop loss
This is a tricky concept, and many factors will determine the answer. For my particular strategy, I want to place stops as far away as possible taking into account recent areas of support and resistance. Here’s why:
- Support and resistance are good technical reasons for getting out of a trade, as they are areas of strong buying and selling. If you’re long, place your stop loss at the last area of major support, because if its broken, it could carry on going much further down.
- Forex has large intra-day volatility, so having wide stops means you won’t fall victim to the insignificant noise (rhythm) of the market. This is why high leverage is bad for beginners. It forces them to place tight stops which get hit all the time (death by a thousand cuts).
How to calculate your bet size using a stop loss
Once you know the best place to put your stop loss, you can calculate the maximum £s per pip you will bet, in order to limit your loss and maximize profit. Here’s an example.
- You think pound sterling will go up, so you buy at the market price of £1.5000. Based on your analysis, you place a stop loss at £1.4950, which is 50 pips below your buy price.
- Your account size is £10,000
- You’re only willing to risk 1% of your account on one trade
1% of £10,000 = £100 (this is the maximum you are willing to lose).
Since your stop loss is 50 pips away, you would divide £100 by 50 pips = £2 per pip as your bet size.
Now you can only lose £100 if your 50 pip stop loss is hit.
These are the basics of a stop loss. In practice they can be used in many ways, based on many factors. But the one thing that will always stay true in forex spread betting is…
Always use a stop loss!