Pulling Out All The Stops: Here's How to Use Stop Orders in

Joined : 23 Dec 2007 Posts : 241 Location : Nigeria

Today's comment is by Sean Hyman, our Currency Director and editor of the FX-trading service, The Money Trader.

A stop order (also commonly referred to as a stop-loss order) is a risk management tool you should use in the currency markets.

You use stop orders to manage the amount of risk in each trade - or how much money you can lose if your trade does not go your way.

If you place a "buy order" (either market or limit order) then you're expecting your selected currency pair to move upward in price. You'll see this reflected on the charts as well. However, if you are wrong in that buy trade, then the trade heads downward. So a stop would need to be placed BELOW your buy order. This way, if you are wrong on the trade, you "stop your losses" at some point.

If you entered the market by placing a "sell order" (also known as "selling short"), then you're expecting the exchange price to go down. If the trade does not go your way, then the pair moves up instead of down. So your stop on a sell short order would need to be ABOVE your sell order.

Where Should My Stop-Loss Go?
Where should your stop be placed? There are many different ways to place a stop-loss.

Some traders will only allow a certain percentage of their account to be at risk at any given time. Therefore, they'll place a stop to where only "X" percent of their account is at risk. A common percentage to risk is 1-5% of your account balance. Don't risk more of your account than this at any one time. Pride yourself in getting your "percent of account at risk" down over time.

Another way to determine stop-losses would be to note the trend line on the chart. If the trend line is broken, then you want to drop that trade because the pair's direction should be about to change. So place the stop at a rate which is below the trend line.

Watch the Yellow Line for When to Get Out

A third way is to consider the average daily volatility and place a stop outside of that range of volatility. For instance, the euro/pound exchange rate (EUR/GBP) averages around 44 pips a day in its fluctuation. However, the pound/yen exchange rate (GBP/JPY) averages around 368 pips per day right now. But then the euro/U.S. dollar exchange rate (EUR/USD's) average is right in the middle at 103 pips a day.
All pairs are not created equal. So using a 50 pip stop-loss may be okay for some pairs like the EUR/GBP. But it's nothing for the GBP/JPY to trade that many pips. This pair could do that effortlessly without even breathing hard. So consider the volatility on a pair when assessing how far away you should place your stop.

Well folks, that wraps up the crash course on stops. I hope you've enjoyed it. Have a great rest of your holiday weekend. I'm sure we all have lots to be thankful about. After all, we're alive today. Some people woke up dead this morning. (That's an old saying to make us thankful for each and every day we have.)

Until next time....happy trading!