Once you’ve done your homework and created an awesome trade plan that includes a stop-out level, you now have to make sure that you execute those stops if the market goes against you.
There are two ways to do that. One is by using an automatic stop and another through a mental stop.
Which one is best suited for you?Here’s where the hard part comes in as the answer to this question lies in your level of discipline.
Do you have the mental toughness and self-control to stick to your stops?
In the heat of battle, what often separates the long-term winners from the losers is whether or not they can objectively follow their predetermined plans.
Traders, especially the more inexperienced ones, often question themselves and lose that objectivity when the pain of losing kicks in and brings in negative thoughts like, “Maybe the market will turn right here. I should hold a bit longer and then it will go my way.”Wrong!
If the market has reached your stop, your reason for the trade is no longer valid and it’s time to close it out… No questions asked!
This is why the almighty forex gods invented limit orders.
New forex traders should always use limit orders to automatically close out a losing trade at predetermined levels.
This way you won’t give yourself the chance to doubt your plan and make a mistake. You won’t even have to be sitting in front of your trading station to execute the order.
How awesome is that?!
Of course, the more trades and experience you have under your belt, the more you will hopefully have a better understanding of market behavior, your methods, and the more disciplined you will be.
Only then would mental stops be okay to use, but we still HIGHLY recommend limit orders to exit the majority of your trades.
Manually closing trades leaves you open to making mistakes (especially during unforeseen events) such as entering the wrong price levels or position size, a power outage, a coffee binge-induced bathroom marathon, etc.Don’t leave your trade open to unnecessary risk so always have a limit order to back you up!
Because stops are never set in stone and you have the ability to move them, we will end this lesson with 3 rules to follow when using stop loss orders.
3 Rules of Setting Stop Losses
Rule #1: Don’t let emotions be the reason you move your stop.
Like your initial stop loss, your stop adjustments should be predetermined before you put your trade on. Don’t let panic get in the way!
Rule #2: Do trail your stop.
Trailing your stop means moving it in the direction of a winning trade. This locks in profits and manages your risk if you add more units to your open position.
Rule #3: Don’t widen your stop.
Increasing your stop only increases your risk and the amount you will lose. If the market hits your planned stop then your trade is done. Take the hit and move on to the next opportunity.
Widening your stop is basically like not having a stop at all and it doesn’t make any sense so to do it! Never widen your stop!
These rules are pretty easy to understand and should be followed religiously especially rule number 3!
DO NOT WIDEN YOUR STOP!
Or you will end up like this guy.
Always remember to plan your trade ahead and figure out what to do in each scenario so that you won’t panic and do something you’d probably regret later on.