The importance of using stops in forex trading

Copyright (c) 2009 Jay Meisler

I did not plan to write on this topic again but the recent fall in the dollar illustrates how important it is to trade with stops. I have been in the forex market for many years and it still amazes me to see traders trade without a stop. I cannot say it any clearer, if you want to stay in the trading game, use a stop loss. This article uses the current market as an example of why traders need to use stops.

I can?t believe I am writing about this again but the recent fall in the dollar has highlighted the need to trade with stops. My focus is the forex market so I can only speak from this perspective but what I say is applicable to not only forex trading but all trading. If you want to stay in the game, trade with stops. I cannot say it any clearer. The purpose of this article is to use the current forex market trends as an example of why a trader needs to be disciplined and use stops.

It feels like déjà vu whenever a trend emerges. I get calls from traders asking what they should do with a long or short position that is deep underwater. I always ask the same question, "Where was your stop?? The usual answer is I didn?t use one. I just don?t get it.

Why don?t traders use stops? There is no clear answer but one reason may be a reluctance to take a loss even though taking losses is part of the business and a pillar of proper money management. This is why ?hedging? has become popular on retail forex trading platforms although essentially it is a flat position and more often than not an excuse not to book a loss. This is a topic for a future discussion.

Another reason why forex traders do not use stops may be that the currency market often trades in a range, even during trends when there is consolidation. These ranges can last for days, weeks or months. During these periods, range trading works and hanging on to a position, even one that is underwater, often gives a chance to recover the loss or even make a profit. The problem is when ranges break and trends take over. In these breakout periods there is often no turning back as a market runs away from the range trader. Those traders who follow a range strategy and trade with stops should be okay. It is the undisciplined trader who trades without a stop that faces disaster, especially in a market, such as forex, that trades with leverage.

Take the current market as an example. Since the start of July and after peaking at 1.6744 on June 30, GBP/USD, with exception of a brief one-day break of 1.60, traded in a 1.60-1.66 range with most of the activity within 1.63-1.66 since the middle of July. This was a good market for range traders as there was a lot of volatility within this range. However, the market broke the top of the range on the last day of July and continued to climb at the start of August to reach 1.7005 on August 4. For those trading a range from the short side and using a stop, this was part of the strategy as ranges do not last forever. For those trading a range from the short side without a stop, the result could be fatal and the trading account wiped out. Even if you were able to stay solvent without using a stop and the market eventually returned to your entry level, the emotional and opportunity costs were not worth the risk.

There are skilled traders who use dynamic stops instead of fixed stops or other techniques to manage a position. However, there is no trader I know of who has stayed in the game without employing prudent money management. For the retail forex trader, this means using stops.

Jay Meisler has been trading the forex market for more than 30 years, as an interbank dealer, fund manager and independent trader. He is a co-founder of Global-View.com, the leading forex discussion site and home of the original forex forum. Global-View is a place where traders come for forex traders ideas, the latest rumor, breaking news and flows =>http://www.global-view.com

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March 11, 2010 | Filed Under Forex Articles 

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