What is a stop loss and why we need one?
Stop Loss is an automatic order that closes our trade once price reaches a specified level. Usually when opening an order we have a choice of entering our stop loss level.
There are 2 types, if we place a sell order then we need to place a stop loss at a certain distance above our entry price. If we place a buy order we need to place a stop loss at a certain distance below our entry price. For Example lets say on EURUSD the price is at 1.22432 and we want to sell so, if we want a 20 pip stop loss. We place it at 1.22632.
Using a stop loss in this way is a method of only risking a small amount of typically between 1% – 5% of our total trading capital per trade. And hence also limiting the losses on our account which puts our minds at rest when trading. The most important part of trading is psychology or put another way its about how you react to that price when it triggers your signal. Or put another way it will affect how you perform as a trader.
When I trade I usually risk about 20 pips per trade. This means if I’m trading at £1 per pip then my risk is £20 and means I would need a total bank of £400 if I was to feel comfortable taking that trade. I wouldn’t feel comfortable if I was risking any more than that and if I don’t feel comfortable then it will affect my trading actions. For example I might hesitate and get in late, or if I see profit but I’m scared I might take profit but this might suffocate a really good trade. So, as we realise getting a stop loss at a level were comfortable with is very important for your psychology which overall will affect your trading decisions which will affect your performance. Just like any sport to that matter.
I’ve often heard it being said that “a true professional trader doesn’t care if he wins or losses”. Well this is true because he knows his method of trading will very probably bring in profit over the long term. What is important is how many trades we win compared to how many we lose and were only going to know this over time. So this is why whether you win or loss if you are a true professional it simply doesn’t matter on one particular day. Its when were losing over many months that tells us we aren’t doing well and need to re evaluate things.