Where Is The Best Place To Put Stops?


Placing no stops on your orders is a dangerous way to forex trade. I once did it and didn’t last too long. I tried to concern myself more about being right rather than just making money. It’s also the lazy way to trade as it gives up accountability and responsibility of the trade. I used to blame an “unknown” outside force, or obtain the opinion of an “expert” who agreed with the direction I took allowing me to hold on for that view a little longer. Once I stopped placing no stops on my orders, it was a game changer.

The key is to find an adequate stop order placement that suits your risk acceptance levels and trade style. This will help you determine where the best place for them are in forex trading – at least until you have more experience under your belt.

I used to HATE using stops because it seemed I would get stopped out only to see the position reverse and continue in the same direction I was facing. I would become furious and want to take my money out of the market because I didn’t know what else to do.

I believe that using a stop order as you trade is hugely beneficial for long-term success in any type of trading environment. It’s all about being disciplined enough with your trades, which may be difficult at first but gets easier the more you do it.

But it came down to my lack of properly testing a system and finding out where the best place was to have my stops for my system. Some systems preferred a simple trailing stop of ‘X’ amount of pips, others preferred a Parabolic SAR stop, and still others preferred a combination of technical and trailing.

Just know: you’re not going to be perfect.

You will have times when you will be pipped out, and the currency runs 100-odd pips in your original direction, and other times when you are saved from a 100-pip fall, but for the times when you are stopped out, and the currency went on to make 100-odd pips in your original direction – who is to say that you cannot get back in? There’s no universal commandment that states Thou shalt not re-enter into a position once thou hast been stoppest out!

But you need to test the idea of re-entering (or maybe widen your stops) to make sure the approach is profitable.

If I’m getting back in after being stopped out, why use stops at all?

Not using stops has your capital tied up into a LOSING position(s) where it could be making money elsewhere (i.e. opportunity cost). Who wants to throw good money after bad?

The answer is: don’t use stops at all. But this comes with its own set of risks – one being that you can get ‘stopped out’ in a strong trend and end up losing more money than if the stop were employed.

If you’re being disillusioned about stop placement, treat it as your apprenticeship. Realise that you will lose money on some positions when you have your stop loss in place, and that the original position would have made money. But, also realise that there are positions you’ll have where your original position would have been massively wrong.

We tend to focus on the lost opportunity more than how the stop loss assisted us. Be fair in your analysis of your stops. Watch when your mind is doing this, focus on the times when you’re stop helped you dodge a bullet, have a folder where you’ve screen captured the result of a good exit.

Stops can help you. You just need to convince yourself and by doing this use a trading journal that shows which stops work best with your trading.

Does stop hunting really happen?

Stop hunting is a term that has been coined to describe the act of anticipating where traders have placed the majority of their stops, having price move to that price point to exit those traders, and then reversing in the original direction of the traders. This can help price move exponentially more in the direction of the original trade because those who get stopped out see price moving in the direction they originally took.

Picture it.

When a trader places their original order and places it alongside their stop loss at a common previous trough or peak, then price moves against them towards their stop loss, and then when their stop loss price is touched, they exit for a loss. Nobody likes losing. So as they watch price then reverse from the stop loss point and head back in the original traders’ direction, other traders who similarly got stopped out, get back in.

It’s this surge of traders who knew they were right, who jump back in quickly. Then as price continues to move in the original direction more and more of the stopped traders jump back in to their original trade to show that they were right.

It’s this combination of traders re-entering back into the market, plus the new traders getting in that creates this momentum on price.

This momentum is the same reason why traders don’t want to set their stop points too close, because they know that if price does indeed move in their favour then there’s a good chance it’ll create this effect which will lead prices even higher.

So is it stop hunting that happens? Or it is just traders jumping on a mild reversal once they’re stopped out that creates new momentum?

Regardless, you need to define how you want to place your stops. And you need to define how and why you would want to re-enter once you get stopped out.

Ways to define your stops

Technical analysis along with the help of indicators can tell us when price could be reversing towards our position, these tools can help guide us into setting more sensible trailing stops.

Popular indicators include: Average True Range Indicator

What is the Average True Range (ATR) Indicator?

The ATR is a simple but powerful indicator that helps traders monitor the volatility of the forex instrument. The Average True Range (ATR) measures true range over the last X number of bars and divides this range by a number (usually determined by the user).

Depending upon your time frame the ATR input should be a good representation of the length of your trade. For example, you don’t want to define the ATR as 20 1-minute bars, if you trade daily. You will stopped out very frequently, unless this is your primary goal – to try and find the turning point during the day. This will mean many stop losses, but then one big win should you time the turning point during the day well.

If a trader uses ATR as their trailing stop point – meaning they want to close at the best possible time – this may be an indicator of getting too greedy or not being able to follow through with good trading discipline. It’s important for any trader to have realistic expectations of the volatility of the currency pair they are trading (which would somewhat be seen in the value of the ATR compared to other currency pairs) and the multiplier used.

If you do use the common ATR input of 14 and a round multiplier like 2, 3 or 5 then you might find other traders at this point who will similarly get “hunted” and cause momentum in their original direction.

To combat this problem, what you could do is use the same input of ATR(14) for your chosen time frame, but then add a random decimal amount to those round numbers. For example, if you are comfortable with an ATR multiplier of 2, then apply an additional 0.31043 to your multiplier, or perhaps have the system automatically generate a random two to three digit number that is added to your multiplier (make sure it’s perhaps greater than 0.1, but less than 0.8). See if using this can help you remain in positions where everybody else is being hunted around common points.

Conclusion

If you have trouble on the correct placement of stops, place them at points where you know the direction that you have chosen will no longer mean to you that the currency is moving in your desired direction. I personally prefer technical based stops on the time frame that I use (such as previous peaks and troughs plus or minus 5-10 pips – as the peak/trough would need to be broken).

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