A stop loss is an indispensable tool allowing you to limit your losses. It is also a level from which you feel that your scenario will not happen anymore. It is mandatory on every position if you want to keep your money safe.
See it like an insurance policy. In case the trade is going wrong, you can be sure that a large part of your capital will be safe. You just need to know how to place your stop.
It also allows you to sleep peacefully because a stop loss deletes the stress and allows you doing activities other than trading. You don’t need to monitor your trade every 10 minutes. The less you monitor your trade the less you risk to make mistakes.
Some people will say that stop loss decreases the winning ratio. Many traders argue to get 90% to 100% of winning trades. Hmmm why not but do they use stop loss? If yes what is their risk/reward ratio?
How to place and manage your stop loss?
- Place your stop loss according to the market price level. It must be placed above or below a key level such as a support, a resistance or a higher/lower.
- Don't place your stop loss on a support, resistance or higher/lower. It is there that you should place your entry point!
- Respect the Risk/Reward ratio. A RR of 2 or more is a key of success in trading. I give you more details below.
- Take into account the of the asset. The more volatile an asset is, the greater is the risk of seeing your stop loss hit on a movement. On a volatile asset, you need to further your stop loss level. This element must be taken into account especially if you carry out long term trades, on daily, weekly or monthly timeframes.
- Never move your stop if the the trade goes wrong! The only context allowing you moving your stop is if the market goes right in order to secure your profit. In this case you can move your stop to the breakeven point (Entry) or more to ensure some profit.
The Risk/Reward ratio, the secret of success
What is the Risk/Reward ratio or RR ?
The RR ratio is the difference between the potential loss and the potential profit of your trade. You simply divide the pips number you expect to win by the pips number you expect to lose.
Assume that you place an order with a TP at 50 pips and a SL at 100 pips then your RR ratio will be 0.5 which means that you will need to win 2 trades to recover the loss of 1 trade.
Now assume that you place an order with a TP of 100 pips and a SL of 50 pips then your RR will be 2 which means that you will need to win only 1 trade to recover the loss of 2 trades.
Never take a trade if your risk/reward ratio is below 1.
A RR of 2 and more is one of the key to become successful in trading on a long run. Imagine the insane performance it would be, if every trade you make had a RR of 2 with 70% of winning trades!
Hope these little tricks will help you improve your trading.
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You must always take into account the winning percentage of your system. So saying "Never take a trade if your risk/reward ratio is below 1" isn´t necessarilly the right way. You might have a system which produces 85% winners but has a 0.5 R/R and be very profitable.
In trading you have 3 key points to handle :
1 - Money management
2 - Psychology
3 - Strategy
In this particular ranking.
Without money management and psychology (except for an EA), a strategy even the best cannot survive.
But still, statistically speaking, a 85% winrate system with 0.5 R/R would be profitable. Psychologically it might be difficult to endure but it does not mean it cannot be traded.
Thanks for the interesting discussion :)