September 07, 2017
Now, let’s explain the most common mistakes that traders make when using stop-losses. Although stop-losses should be used on every trade as a part of your risk management, try to avoid the following mistakes:
Placing Stops Too Tight
This is one of the most common mistakes traders make. The forex market can fluctuate unpredictable in short periods of time, and if you place your stop too tight, there is a high chance that you’ll be stopped out before the price continues to go in your direction. It’s important to give the price enough room to “breathe” when considering where to place your stop-loss.
For example, placing a 10-pips stop loss while entering a long position on the daily EUR/USD chart, will most likely close your position in a matter of minutes (although you intended to hold the position for a few days). Always consider the price volatility of the pair.
Using a Pip or Dollar Amount as a Basis for Stops
You should always place your stops based on actual market behavior. Using a stop-loss based on an arbitrary pip or dollar amount has nothing to do with the market. Remember what you learned in the previous chapters about how to determine your position size based on risk per trade. Always use a sound analysis to place your stops.
Placing Stops Too Wide
Another common mistake is placing stops too wide from the entry price. In this case, stop-losses lose their actual purpose. You should always care about your reward to risk ratio. For example, placing a 500 pips stop-loss on an intraday trade, requires a 1,500 pips profit target to maintain a 3:1 reward-to-risk ratio. Most currency pairs don’t move 1,500 pips in a month.
Placing Stops Exactly on Support or Resistance
Support and resistance levels are useful targets for placing your stops, but you should always place them a few pips above or below these levels. Even if the support and resistance levels hold, the price tends to at least touch them before changing direction. You would be closed out even if your trade had a high-probability of success.
Don’t Let Emotions be the Reason You Move Your Stop
Once the price goes against you and hovers very close to your stop, it might be tempting to move your stop. If you do this, you let emotions override your analysis. You should never do this, unless you want to lose more money in the long run.
Do Trail You Stop
A trailing stop moves in the direction of a profitable trade by a predetermined amount of pips. This is a good idea, as it locks in profits and still gives the price enough room to breathe. However, you should aim to set a reasonable pip-amount for your trailing stop. A 5-pip trailing stop would not be of much help and you could get closed out too soon.
Don’t Widen Your Stop
This is a very similar mistake as moving your stop based on emotions. Once the price hits your stop, you should move on a look for other trading opportunities. Nothing positive comes out of widening your stop. You’ll only accumulate losses in the long run.