Importance of stop loss placement in forex trading

Justin Bennett is a Forex trader, coach and founder of Daily Price Action. He began trading equities and ETFs in and later transitioned to Forex in His "aha" moment came in when he discovered the simple yet profitable technical patterns he teaches today.

Forex Trading: Importance of Stop Loss Placement

Justin has now taught more than 1, students from 53 countries in the Daily Price Action course and community. Follow JustinBennettFX Recent Lessons. What Forex stop loss strategy should you use? One strategy in particular my favorite will help you sleep better at night when trading the higher time frames. As a forewarning, this lesson turned out to be much longer than I intended. This goes for both bullish and bearish pin bars.

For the inside bar trading strategy, the stop loss can be placed in one of two places. The advantage to this placement is that it provides a better risk to reward ratio. The disadvantage is that it opens you up to being stopped out before the trade setup has had a chance to play out in your favor.

This then is obviously the riskier of the two inside bar stop loss placements. As mentioned previously, the safer placement behind the mother bar is ideal in choppier currency pairs. Well I guess it does involve hands to place the stop loss. The key is to avoid the temptation to adjust your stop loss while in the trade. The Hands Off approach reduces the chance of being stopped out too early by keeping your stop loss at a safe distance. We all know the feeling of moving our stop loss too early and being stopped out, only to watch the market take off in the intended direction.

You simply set the stop loss and walk away. As previously mentioned, the Hands Off stop loss strategy is not without flaw. Using the Hands Off Forex stop loss strategy can also tempt you to move your stop loss. No lesson on stop loss strategies would be complete without discussing the controversial break even stop loss.

So why would I want to move my stop loss to an arbitrary level? Most traders who move their stop loss to break even will tell you that they do it to protect their capital. Everything we do in price action trading is based on price action levels, right? Anyone in the world can see these levels, which why they work so well. Nobody else knows where you entered your trade, nor do they care. Once in place, any market movement to your original entry will be protected by your stop loss.

Moving to break even means no market analysis is needed. The only place for you to move your stop loss is to your original entry point. You always know exactly where your stop loss should be placed. A break even stop loss hinders your odds of success. By not giving your trade setup enough breathing room to play out in your favor. Above all, moving your stop loss to break even is lazy.

How is this a disadvantage? When a trader moves a stop loss to break even, they are moving to a level that they have decided is important. Yes, it does involve cutting your risk in half or thereabouts.

Once the market closes on the second day after our entry, we can use the low highlighted in blue as a place to hide our stop loss. This may be acceptable for some and unacceptable for others.

In this case leaving the stop loss at the initial placement might be the better decision. This would reduce the stop loss from pips to 50 pips. Notice the grey line I have drawn on this chart. This represents a short-term level in the market and could give further conviction to the decision to move the stop loss from the high of the mother bar to the high of the inside bar.

The next strategy is useful once the market starts to move in the intended direction. This is where the trailing stop loss comes in handy. The first is automated, which is where the stop loss is set to trail price by a certain number of pips. Most trading platforms nowadays offer this feature. The second way is to manually trail the stop loss. Both ways of trailing a stop loss will be explained below, but this section will only focus on the manual way. Because just like the break even stop loss, the automated way of trailing a stop loss is based on arbitrary levels that have no real significance in the market.

The market immediately moves in your favor up to 1. So where is 1. Who knows…there in lies the problem. This is where it pays literally to trail your stop manually using price action levels as the basis for your decision.

The basic principle with manually trailing your stop loss is the same as the automated way. It goes without saying that not every trade will work out this perfectly.

My initial profit target was pips away. So right off the bat this represented a 4. Although I focus on money risked vs.

That was the potential gain on this one trade. On the second day 2 above my order to go long was filled with my stop loss 35 pips below. This immediately cut my risk by more than half. Instead of risking 35 pips I was now risking 15 pips. This brought my 2.

Why did I do this? I figured if there was any chance of a push higher it would come without breaking the low of the inside bar on day 2. Once day 3 closed, I was obviously in the green and had the bullish conviction I was looking for. Notice how day 3 closed — just a few pips from the high of the day. Price action signals such as this can also tell a lot about a market. The rest is pretty self-explanatory.

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So what was the total percentage gain? I was initially risking 2. This is the icing on the cake so to speak. There is nothing complicated about this stuff. No proprietary indicators or confusing algorithms.

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Why I Ditched Technical Indicators And Why You Should Too. How to Profit From the Head and Shoulders Pattern And Avoid Common Mistakes. Trading the Broadening Wedge: Your Start to Profit Guide. How to Use Fibonacci Retracement to Spot Market Tops and Bottoms.

The 3-Step Approach to Forex Money Management and Risk Control. A Simple Yet Powerful Approach. The Inside Bar Trading Strategy For the inside bar trading strategy, the stop loss can be placed in one of two places.

Advantages Reduces the chance of being stopped out too early Helps to reduce emotional trading Extremely simple to implement The Hands Off approach reduces the chance of being stopped out too early by keeping your stop loss at a safe distance. The Break Even Stop Loss No lesson on stop loss strategies would be complete without discussing the controversial break even stop loss.

Let me explain… When a trader moves a stop loss to break even, they are moving to a level that they have decided is important. So how can we protect some capital AND use price action levels to our advantage? The Manual Trailing Stop Loss The basic principle with manually trailing your stop loss is the same as the automated way.

Forex Stop Loss Strategy: In closing… This is the icing on the cake so to speak. What Forex Stop Loss Strategy Do You Use? Copyright by Daily Price Action, LLC.