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Posted on Nov 22, 2018 at 04:35 PM
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MONEY MANAGEMENT SERIES #2: WHAT’S THE BEST WAY TO TRAIL YOUR STOP LOSS

After the break and the retesting to trail your stop, what's the next thing to do in order to effectively trail your stop loss? Find out below!

Are you new here? You must have missed the first part of the series! Just click here to catch the first part before continuing with this series.

STEP 3. TRAIL YOUR STOP LOSS

The last step involves actually moving the stop loss order. While the exact methods for this vary according to trading platform, the industry standard Meta Trader4 (MT4) allows you to simply drag the order to the new position while on the charts or to modify the price for the new position. Ensure to check with your broker if you’re in doubt.

The position of the new stop loss depends on how the market retested the level in step two. Ideally, the order should always be placed at a level that would negate the trade idea, if achieved. That is; a price lower than entry price for a Buy/Long position, and, a price higher than entry price for a Sell/Short position.

Let’s go back to the EURUSD example.

 trailing_stop_loss 2

Upon retesting the key level as new resistance, the pair sold off quite aggressively. My stop loss would now go approximately 10 to 20 pips above the high of that candle.

At this point, if the euro were to rally and take me out of the position, there’s a good chance it would continue higher so the positioning above makes sense.

You continue to do this until the market either reaches your Take-Profit target or hits your stop loss. Notice how EURUSD behaved the same way following a subsequent close below the next key level.

To be clear, there is no way to know if the market will move beyond the first support or resistance level. You’ll need to use what you’ve learned about price action or chart analysis to determine whether momentum is strengthening or weakening.

THE 'LAZY' METHOD

If you’re trading a strong trending market, you can use a two-candle rule to determine when to start trailing your stop loss.

Allow me to explain…

The first step is to wait for your entry strategy on your desired timeframe to form a trade setup following your entry. During this time, your stop loss remains in its initial position.

Provided the market is still trending in your favour, you would move your stop above or below the candle that formed after your entry. In other words, your stop order will always be at least 2 hours behind the current price.

By waiting for two candles to close, you allow the market to move away from your entry. Again, this only works well in a trending market.

You can make it three, or even four candles if you want. There’s no hard and fast rule here, as it comes down to whatever works best for you. It will also depend on your anticipated holding period or desired number of Take-Profit pips.

Just know that a three-candle close may allow you to stay in the trade a little while longer. However, it also means you could give up more unrealized gains, should the market reverse on your trade position.

MOVING YOUR STOP LOSS TO BREAK-EVEN

Let’s imagine for a moment that you just sold the EURUSD. After a few hours you check back in to find the pair has lost 30 pips.

Apparently, the ECB dropped a bombshell that didn’t sit well with Euro bulls. That’s good news for you.

It’s getting late so you decide to trail your stop loss to break even before going to bed.

The next morning you roll over to look at your phone and see an alert from your broker that your stop loss order was triggered.

BANG! But hey, at least you moved that stop to breakeven, right?

You finish your morning routine and decide to check on the markets for an entry. To your dismay, you find the EURUSD trading 100 pips lower from the breakeven stop loss you set the night before.

Upon seeing this, you decide to sell now. You’ve already missed 100 pips and you sure as heck aren’t going to miss out on the rest of the move.

By the end of the day, the EURUSD has bounced by 40 pips. Not wanting to hold the position overnight, you decide to get out for a loss.

You went to bed the night before with thoughts of profits, woke up with no profits, and now you’re about to go to bed with a loss of 40 pips.

Does any of that sound familiar?

I bet it does. Even writing this scenario takes me back to my early days when I’d trail my stop-loss too soon and take trades based on the “fear of missing out (FOMO)”.

SO WHAT’S THE SOLUTION?

Simple. Give the market room to breathe. Don’t make the mistake of moving your stop loss too soon, simply to avoid a loss.

Instead, listen to the market. It will always tell you when it’s time to begin trailing.

Trading is a balancing act. Although your number one job as a trader is to protect your capital, your second most important job is to let winning trades run.

You can accomplish both by reducing your risk. If you’re only risking 1% or 2% of your balance on each trade, you’ll be much less likely to trail your stop loss too soon.

By reducing your risk, you’re effectively protecting your capital and increasing the likelihood that you’ll let winning trades run.

FINAL WORDS

Like most things, there is no right or wrong answer here. It comes down to what you prefer and what gives you the best chance of coming out ahead in the long run.

Remember that your number one job as a trader is to protect your capital. That can’t be overstated. One way you can do that is by using a stop loss order on every trade.

Whether you trail it or not is up to you. However, knowing that protecting your capital is a priority can serve as a guiding light. In most cases, you’ll find it appropriate to trail your stop loss, at least to some degree.

It’s a balancing act though. You need to trail your stop to protect your capital, but you also don’t want to suffocate your trade by moving it too soon. After all, your winning trades have to pay for the ones that lose.

Your Turn: Ask Me Anything

I’d love for this weekly Q&A to be successful and provide an invaluable inventory of answers to common Forex questions.

To do that, I need your help.

Here’s what you can do to get involved and have your question answered in next week’s post:

  • Ask questions. Post them in the comments below or Tweet them to me @instafxng
  • Help me answer questions. If I missed something or if you have something to add, don’t hesitate to leave a comment below.

 


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Previous Comments

  • EMMANUEL OLUGBADE ADEOSUN
      Nov 28, 2018 at 02:36 PM

    Thanks for this educative and useful series. My question is How can pending orders viz BUY LIMIT, SELL LIMIT , BUY STOP AND SELL STOP be used for profitable forex trading?

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