the first step is to decide how many percent of your account balance you’re willing to put at risk. in our case we’re trading one AUDNZD contract a day with risk exposure of 2% - 4% daily - depending on signal strength of our forecasting model.
let’s have a look at an example: we have a 5k account and decide to risk 3% = €150.- how do we now translate these €150.- into a pip distance for the s/l? in case of a buy signal we look at recent support lines. the time frame for “recent” might vary with the pair in question. with AUDNZD we look at the one week chart. let’s assume that support has shown at 40 pips below the current quote. what we do now is set the s/l at 50 pips.
if the support price holds again the s/l won’t be triggered and we’ll stay in the contract. if it gets broken and the quote plunges into a hole we’re out of it very quickly at 10 pips below the old support. of course the s/l could be triggered and the pair could go back up but that’s simply part of the game and it won’t happen too often. after 20 years of trading FX i know that this approach absolutely does make sense.
after having picked the 50 pip s/l we know chose a leverage of 50k on the trading account which corresponds to €3 per pip and therefore €150.- in case the s’l is triggered.
please make sure to never ever widen your stop loss in hope of a trend shift! this is the nr.1 mistake in FOREX trading and the graveyard of FX accounts is full with desperate trend swing expectations. when you’re out of the tradde - you’re out of the trade. period. have a beer and focus on a smart trade setup for tomorrow. it’s no shame to lose trades and your ego will just have to learn to live with it. never let emotions llike greed or fear get involved into your trading decisions. emotions can easily ruin an otherwise successful trading strategy!
so the variable to use for setting the right s/l in terms of € is leverage. support/resistance gives you the pips - leverage gives you the €.
in case of the quote being very close to your support/resistance this small pip distance would not be useful as s/l.
example: if the quote is 10 pips above your support line on an UP - signal you’ll need to set your s/l lower than these 10 pips. we use a minimum of 25 pips and therefore a maximum leverage of 100k in our 5k account example on the AUDNZD trades. we mainly check daily volatility data to come up with a rational pip distance. we check average open/high and open/low over a period of up to threee months. these stats are very useful since they tell you how many times your s’l would have been triggered in the past.
the important point is: if you chose a small pip distance for your s/l you’ll get kicked out of the contract more often BUT your leverage is higher and you’ll earn more on a winning trade. the whole thing is a very sensible trade off which can be mastered by detailed stats, a good trading journal and constant backtesting. doing all that work will definitely pay off in terms of higher returns without having to improve your basic buy/sell decision model. that’s a whole different topic. when having done all that work all you have to do is STICK TO YOUR PLAN!
well, i hope you liked this little intro into the stop loss topic. i’ll be writing some more on this with detailed excel stats and charts in the next days.
cheers juergen