Using Stop-Loss Orders to Manage Risk
Due to the importance of money management to long-term successful trading, the use of a stop-loss order is imperative for any trader who wishes to succeed in the currency market. The stop-loss order allows traders to specify the maximum loss they are willing to accept on any given trade. If the market reaches the rate the trader specifies in his/her stop-loss order, then the trade will be closed immediately. As a result, the use of stop-loss orders allows you to quantify your risk every time you enter a trade.

There are two parts to successfully using a stop-loss order: (1) initially placing the stop at a reasonable level and (2) trailing the stop – meaning moving it forward towards profitability – as the trade progresses in your favor.

Placing the Stop-Loss

Here are two recommended ways of placing and trailing a stop-loss order:

· Two-Day Low. This technique involves placing your stop-loss order approximately 10 pips below the 2 day low of the pair. The idea behind this technique is that if the price breaks to new lows, the trader does not want to hold the position. For example, if the low on the EUR/USD’s most recent candle was 1.2900, and the previous candle’s low was 1.2800, then the stop should be placed around 1.2790 – 10 pips below the 2 day low – if a trader wishes to enter. As another day passes, the trader can raise the stop to 10 pips below the new two-day low.

· Parabolic SAR. One type of volatility-based stop is the Parabolic SAR, an indicator that is found on many currency trading charting applications. Parabolic SAR is a volatility-based indicator that graphically displays a small dot at the point on the chart where the stop should be placed. Below is an example of a chart using Parabolic SAR.

Based on the parabolic SAR, the stop loss in the chart below would be close to 400 pips???

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You are correct, if we place trades based on the longer-term charts such as the daily charts, we will naturally have to give the stop orders more room as well as our signals to enter the market. However, once we have an open position with a floating profit, we can stop 1/2 the position through the use of a shorter term chart such as a 1-hour chart. We can then use a daily chart to maintain the stop order for the remainder of the position.



The following 1-hour chart illustrates that as the market touches one of the "SAR" points; we must stop out our current position, and initiate a position in the opposite direction.

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Based on the Two- Day Low technique, when doing intraday trading (15-30 min), how should I place the stop-loss?
Thnx

The 2-day rule simply dictates that we must place our protective stops below the low price during the previous two trading days. As long as the market does not turn back down, to trigger our stops, we can continue to raise our stop every day. The following 1-hour chart illustrates that by using a 2-day stop, we can participate in the trend as long as it continues, while we can protect a good amount of our profits.

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Which are the times frames the PSAR works best?

As with any technical indicator, the longer-the time frame, the more reliable the signal. There is a direct trade off between timeliness and reliability. When trading the FX market, and most other markets for that matter, we can select many different time periods. Most charting applications give us the opportunity to select a 1-minute chart up to a monthly chart, and many options between the two. Regardless of the time frame of the chart, the same principals of support, resistance, range bound, and trending markets continue to apply. Often times, traders will start with a longer-term chart to determine the ‘major’ support and resistance and market theme. From that point moving forward, traders may move to a shorter term time period to have a closer look at recent market activity. As a general rule of thumb, the longer a support/resistance line or trend exists, the stronger it becomes. If the market breaks a 10-minute low, this probably will not affect the market to a large extent. However, if the market breaks a 1-year high or low, the subsequent move may be far greater. For that reason, traders tend to react to the longer-term charts more seriously.

This is another great subject matter I have enjoyed in the lesson.

The idea of placing stop-loss at 10 pips below previos 2 days low sounds appealing but the RISK-REWARD ratio seems very unattractive. Hence, it is my opinion that SUPPORT or RESISTENCE level and general trend direction and momentum need also be considered besides the omni-present Fibonacci retracement, the famous candle sticks patterns and upcoming economic release.

As a intra-day trader, I would like to GIGO (get in and get out) within 4 hours with a reasonable profit. In this scenario, I would appreciate if you would please share your own successful trading experiences!

It's a great question, we should place our protective stop orders at a logical point on the chart, where the markets “should not trade” if our trading assumption was correct. For example, if the low of the day is 1.3025, and we believe that this level is now our new support, and the market should not trade any lower, then we can place our protective stops at 1.3010, for example. If the difference between our entry and stop order represents too much potential risk, then we can either decrease our position size and/or lower the entry level. The closer we can enter the market to our protective stop order, the better the trade and less risk that is taken.