Anytime that you are investing in the Forex market, you are going
into the Market blind. You don't know what point of the investing trend
you are entering in at. You might be investing in a Forex stock just
before the trend changes. Smart investing means you need to protect
your trading float and set up a stop loss. This needs to be done before
you enter a trade, so that there is no room for error, or last minute
indecision. A stop loss is simply a predefined point at which you exit
Effectively, it's like drawing a line in the sand underneath
the share price, saying, "If the share price falls below this line,
then the stock hasn't done what I thought it was going to do, and I'll
exit the position."
This allows you to protect your investing trading plan,
because it cuts your losses short, and guards against an all too human
tendency to want to believe you must be right.
95% of investing in an entry Forex position means you are
expecting to profit from the trade. If, however, the share-investing
price goes against you, you might feel the need to justify why you
bought the stock by holding onto it until it turns a profit. You might
have heard the idea that all big investing losses once started as small
losses. Well, while the share price continues to go in the wrong
direction, those losses grow in lockstep. This is why you need to have
a stop loss in place — it's like having an ejector seat that tells you
when to abort the mission.
One of the most common question I'm asked when traders are introduced to a stop loss is "How wide should I set my stop?"
In other words, how much room should I give the stock to move?
There are no definitive answers to this question because it depends on
what time frame you're investing in. If you're a shorter-term investing
trader, you're going to have a stop loss that's set closer to the share
price. If you're a longer-term investing trader, you'll give the share
price a little bit more room to move and set your stop loss lower.
Once you've identified what time frame you're looking at
trading, you need to be able to remove the normal market noise
(volatility) in that particular time frame. You don't want to have to
close out of an investing position just because a share price moved a
little bit due to its normal trading volatility.
In fact, there are some serious drawbacks to setting tight stops.
First, you'll decrease the reliability of your system because you get stopped out more often.
Second, and probably a little bit more importantly, you
dramatically increase your transaction costs, because you're trading
transaction costs make up a major proportion of your business expenses.
To give yourself a fighting chance, you want to trade a system
that doesn't chew through excessive brokerage fees. This is one of the
major reasons I steer my clients into developing a trading system that
runs over a slightly longer time frame. With the correct system in
place, and your investing risk minimized, you are well positioned to
maximize your trading profits.