Top Psychological Pitfalls for Forex Traders

You will probably hear quite a similar response if you were to question any accomplished trader what allowed them to save their account from a terrible account blowup - stop loss. Stop loss orders are essentially the safety nets of trading. They will not guarantee profits, but they will prevent you from allowing a small loss to turn into a debilitating loss. 

What many beginner traders do not understand is that there are actually more than one different stop-loss style, and each different type has there own purpose - this depends on your style of trading, and also the current type of market you are experiencing. 

What is a stop loss? 

A stop loss is a standing order to close a trade - the order will close the trade once the market hits a given price level. A stop loss is set to limit your loss and protect your capital. If you did not have a stop loss, then you are admitting to letting your emotions takeover and you will hold a losing trade well past the limit has finished. 

Think of a stop loss just like a fire alarm in your house. You hope to never need it, but if things start to go bad, it will spare you from far worse damaging. 

1. Fixed (Standard) Stop Loss 

This is the most basic stop loss. You start the trade at a price, and then set the stop loss at the price level, if the market hits it that would automatically close the trade. 

For example, if you enter a long trade for the EUR/USD at 1.1000, then you have set the stop loss for 1.0950 - you have just capped worst case loss to 50 pips.This type is good for traders who seek simplicity and clear boundaries. The downside is in volatile conditions, you might be prematurely stopped out until the trend resumes.

2. Trailing Stop Loss

A trailing stop follows the market as the market moves in your favor. While the trailing stop follows, it is correcting itself and locking in the profit, but still allowing the trade to run.

For example, if your trailing stop is 30 pips, if your trade moves up 50 pips, your trailing stop will follow behind, now protecting at least 20 pips in profit in case of a reversal.

It's like a safety rope that climbs with you up a mountain, always feeling secure, as you continue to reach refinements in the move.

3. Stop Loss in Volatility

Some traders likes to place stops based on volatility and not as numbered. They use something like the Average True Range (ATR) to measure a safe distance.

On a calm day, your stop might be tighter, and a more volatile day you give it more room because you do not want to get shaken out. The goal is to follow the conditions and protect against "noise" stops, that are not trades, but simply small moves.

4. Guaranteed Stop Loss

This option is not available with all brokers, but when it is, it is a great option.A guaranteed stop loss means your position will close at the precise level you specified, with no slippage or unwelcome surprises.

This feature is especially useful when trading stock or currency pairs around news, as it is theoretically simpler to execute when news is released, especially when prices may gap. The downside is brokers normally charge a premium for that level of protection.

5. Mental Stop Loss

Some traders use what’s called a mental stop: traders do not place the stop in the system and simply decide to close the trade at a certain point.

While that can appear flexible, it can also be a significant risk. Emotion tends to override discipline, and traders often will have those losses much longer than they would have otherwise. A mental stop takes discipline, and many lack it.

Comparing the different types

To summarize

Picking the right one

For most traders, there is no “best” stop loss; it comes down to personal preference based on your style. If you are someone who appreciates structure, a fixed stop is simple and reliable. If you are looking for flexibility, then a trailing stop or volatility based stop might be a good option. If you trade on significant news, a guaranteed stop may give good protection.

Regardless of which type of stop loss or not, it is important to have some form of protection. No strategy will win 100% of the time, and stop losses are simply your insurance policy, so you can place another trade tomorrow! 

Final thoughts

Stop loss orders may not be the most thrilling aspect of trading, but a powerful argument can be made that they are the most critical. From fixed levels of stop-loss orders, to trailing stop, to volatility stop loss orders, in various styles provides ways to control risk and exposure.

Smart traders realize it’s not about not losing, it’s about who can limit their losses. If you want to learn more about stop loss orders and how, you fit them into different trading strategies, be sure to check out the Learn section of WikiLix so you can get guides and other resources to best learn that knowledge into habits.