There are various ways of setting stop losses. We will discuss the popular ways here under;
1. Percentage stop
Setting a stop loss target using the amount of money you are willing to risk per trade.
Taking in consideration the kind of a trader you are, the market range you are trading and using your desired position size, you can determine the amount of money you are willing to risk in pips and rely on that to set your stop loss level.
For instance if you are risking $20 from your $500 account per trade using a size of 10,000units, this simply means that every pip movement is equal to $1 i.e the pip value. Therefore the total number of pips that can match your stop loss will be (the risk amount per trade/position size)
Which is (20*1) =20pips. If $1 is equivalent to 1pip then the $20 will be 20 pips.
So it will require you to set your stop loss on account of 20pips below or above the entry point depending on whether you are going long or short.
2. Volatility stops.
Understanding the market conditions you are in helps you to know how long a currency pair is likely to move and you will be able to determine the appropriate targets for your trade.
When you set your stops too close when volatility is very high, you will be knocked out of the market prematurely and if you set it far in a less volatile market you will be forced to use a very small size to fit your stop loss hence folding your profits within.
When volatility is high traders tend use large stop loss so that they are not prematurely knocked out by large swings. When it is low use small stops .
To have an appropriate risk reward your stops should be relatively connected to the target profits. So as you intend to widen your stop loss during periods of high volatility, you should do the same for the profit target. This should also be considered when volatility is low.
Within a less volatile market, your targets should not be very far from the entry because price may not be able to reach your target profits.
The common indicators used to measure volatility are:
Average True Range (ATR) indicator
ATR measures volatility. ATR does not say anything about the trend strength or the trend direction, but it tells you how much price fluctuates.
High ATR signals that past volatility is relatively high and price tends to move further within that time horizon.
The greater the ATR reading on a particular pair, the wider the stop loss that should be used. The reverse is true.
Here the upper and lower bands are used to set stop loss levels. When trading with Bollinger bands, Set stop loss slightly below the lower band or above the upper band for ranging markets.
If price breaks on the either side of the band it indicates an increase in volatility. Knowing the price boundaries, you will be able to choose a suitable level that is enough to keep you in the game.
With Bollinger bands when the bands expand, it is an indication of increasing volatility in the market and on contraction it indicates a fall in volatility. Check Bollinger band trading here!
3. Chart tops and bottoms
Swing traders follow the market trends which is defined by tops and bottoms formed by candlesticks, pivot points, etc.
These previous highs and lows provide confluence levels on which you can rely and choose an appropriate target for stop and profit.
If the current top is lower than the previous top or the current bottom is higher than the previous one, the the previous one acts as the stop level zone.
Highs and lows usually form zones of resistance and support so traders usually place there stops on the other side of these technical levels.
Take a look at the chart below. When a bottom/low was formed and then price formed a new higher low, the first/ previous bottom was used as the stop loss level zone.
4. Time stop
When trading forex, it is sometimes quiet and slow or noisy with very large price movements in the market.
The market is usually quiet and slow towards the closing of the day or the opening of the first session since there are a few participants. And it is very volatile or noisy during the release of most important economic news and the overlapping of the two trading sessions.
These quiet times are usually characterised by congestions and tight ranges. So for these times, you can use smaller stops since we have low volatility.
Volatile sessions have large movements therefore you must use wider stops.
Take a look at the EURCHF, Hourly chart below;
The market was slow in a channel and then there was a strong break out to the downside. This indicated new strong momentum, this calls for a wider stop level above the channel high
When setting stop levels with time stops, they MUST be based on the referred time to trade. Tradind specific sessions and time periods require different stop loss sizes.
How long you should hold an open position, is a personal thing for all traders. The decision is all yours. You know what your goals are as a trader, the kind of strategy you use to trade. All this starts from what you are? and What you want? If I am to answer, this...