Where Is the Best Place for Stop Loss and Limit Orders?

Category: Technical Analysis | Sunday, January 27th, 2008

Stop Loss and its proper position is the question that I have been asked by forex traders so many times. What is the best place to put the stop loss and limit orders?

Stop loss is a must. You have to have it when you trade even if you are an intraday trader and you sit at the computer and watch the price movement and all your positions are closed at the end of your trading day.

Stop loss position is very important. Sometimes having a tight stop loss will be nothing but a loss because it will be triggered even when you choose the right direction.

Stop loss should be placed in a position that will be triggered only when the direction you have chosen is absolutely wrong. For example the price is going up. You wait for a reversal signal. The price changes its direction and starts going down and you take a short position. So the pick that the price has made before it goes down is a resistance.

Now a question: When you will be realized that taking a short position has been a wrong decision and the price will keep on going up?

Yes; only when it goes up and breaks the resistance. It means it goes up and goes higher than the point that it changed its direction and went down. Otherwise you have chosen the right direction.

So where should you place the stop loss? A few pips above the pick (resistance) plus the spread.

When you take a short position, you have to add the spread to the value of the point that you consider as the stop loss because when you take a short position (you sell) you have to buy to close the position and when you buy you have to pay the spread to the broker. So your stop loss should be a buy order and you have to add the spread to it. This is very important when you trade with the currency pairs that have a high spread. If you don’t do that, your stop loss will be triggered sooner and when the price has not gone over the pick.

But when you take a long position (you buy), you don’t have to add the spread because you paid it when you bought.

Let me shows you some examples.

1. In this example, you take a short position at 211.74. As I explained above, if the price goes up and breaks the resistance, it means the taken position has been a wrong position. The resistance is at 212.39. To place the stop loss, I add 3 to 5 pips to the resistance plus the spread.

So in this case the stop loss will be 212.39 + 5 pips + 8 pips = 212.52

2. In this example you take a long position (you buy) at 214.37. The support is at 213.56 and the stop loss will be 5 pips under the support line which will be 213.61.

3. Now lets say you take a long position at 1.4642 after the triangle breakout. As you see in the below chart a symmetrical triangle is broken up. The big Bullish candlestick is a good confirmation that the triangle resistance is broken and so you take a long position when this candlestick is fully formed. But where should you place the stop loss?

It is always possible that the prices changes the direction to retest the broken support or resistance but if it succeeds to break the support or resistance after retesting, your position should be closed because it is possible that the price keep on moving against your direction.

In this example, your long position should be closed if the price goes down, retests the broken triangle resistance (will act as a support after breaking), breaks it and then keeps on going down. To determine the stop loss position, you have to extend the triangle broken resistance and then find a suitable position under the broken resistance. In this case it is 1.4588.

As you see there is no special rule for stop loss like “your stop loss should be 50 pips under the buy price…”. Stop loss position is different from one trade to another one even with the same currency pair and time frame. Sometimes your stop loss will be 20 pips under your buy price and sometimes it has to be as high as 200 pips.

When you work with bigger time frames you use the above stages to determine your stop loss position but as the bigger time frames have bigger scales, your stop loss value will be much bigger.

Move your stop loss!

When you see that the price moves to your favorite direction and you are making profit, you should cancel your primary stop loss and set anther one, higher than the primary stop loss. For example you have bought EUR-USD at 1.4246 and your primary stop loss is 1.4588. The price goes up for 50 pips. You will have to move your stop loss 50 pips higher which is 1.4638. Then if it kept on going up for 50 pips more, you will have to move your stop loss 50 pips higher than the second stop loss.

This is a good technique to maximize your profit when the price keeps on moving to your direction for a long time. But keep in your mind that it doesn’t mean that you have to wait until the price hits your stop loss. To protect your profit, when you see a clear reversal signal, you should close your position immediately and before it hits your stop loss.

50 pips in this example is just an example and is not a rule that has to be obeyed in all trades. It depends on the conditions and trade. For example when you just open a position at the beginning of a candlestick, you have to wait for the candlestick to be formed completely and then decide if you want to move your stop loss or not. You don’t move your stop loss immediately when the price moves to your direction.

Ok! Hope the above explanations were clear enough and you learned how to set your stop loss. In case you have any question, just leave a comment and I will get back to you shortly.

How about limit?

Limit is a good thing to fix your profit before you lose it and of course it is a good thing to limit and control your greed. It is better to keep a trade as long as it is moving to the favorite direction and there is no reversal signal but you can set a limit and fix your profit. You should not get upset if the price keeps on moving to the same direction for several hundreds of pips after hitting your limit. You are already out of the game.

Determining the limit can be very easy if you make a rule for yourself. For example you say “I will be happy with 20 pips and want my position to be closed when I have made it”. But it can be hard and complicated if you want to determine the final destination of the price and set your limit according to it. It is always possible that the price doesn’t move according to your predictions and so it changes its direction before hitting your limit. So you have to be careful.

If you like to earn the maximum profit, you have to determine the final destination of a trend. This can be challenging. First you have to find all the supports and resistances. You have to use the Fibonacci levels in the best way. When you have a long position, any of the Fibonacci levels can reverse the price and so they can be your limit.

The only case that is easy to determine the limit is trading a channel which is when the price is moving inside a channel and goes up and down between a support and resistance line. But even in this case, sometime the price changes its direction before it hits the limit.

What is OCO?

OCO stands for One Cancel Other. An OCO order includes a stop loss and a limit order. Any of them that becomes triggered, the other one will be cancelled automatically and so it will not be triggered later.

The last thing I want to say is that keep in your mind that you MUST cancel all the pending orders including stop loss and limit when one of them is triggered or you have closed your trade by yourself otherwise you will be in trouble because they will be triggered when you have no position and you are not at the computer and so they will open a new position and you don’t know where the price will move. It can be ended to big losses. I have lost a lot of money because of this stupid mistake. So be careful.

Further Reading:

34 Comments:
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Comment by Ateeq

2008-01-27 14:01:08

hi vahid

you just confirm my thought. this happened to me on my 5 trades last month, coz i used the supoort as my stop loss and after hitting my stop loss, price went on to my target. then i realized the spread and little bit of slipage. this report gives me more confidence on my stop loss problem. you are the MAN.
God bless you
ateeq