In forex, trading without a stop loss is pretty dangerous. I remember when a friend and I were trading and suddenly the internet went out. We were freaking out! What was the market doing? Were we losing all of our account balance? If we had placed an immediate stop on the order, we would have had a type of insurance. A few minutes later the wi-fi came back online and we were relieved to see that our trades were just fine. No major losses, no major wins. We immediately entered our stop loss orders and breathed a sigh of relief.
A stop protects against loss, similar to insurance. I usually use a trailing stop when I am trading the Euro or other forex instrument. Here is the main reason that a trailing stop is like insurance.
Asset Protection
When you are trading with live money and attempting to generate a return, you have assets in the market and money on the line. A trailing stop is the insurance that protects the asset. With something like auto insurance, the policy protects the asset which is the car. Asset protection is important for peace of mind. It’s important to trade like a robot but that can be hard to do if your emotions are at play. When you have car insurance, you should feel more comfortable if an accident were to happen. You will be properly compensated if you were not at fault. Similarly in the markets, if you take the wrong side of the trade, a trailing stop will prevent the loss of your entire account; it will provide asset protection.
How Does a Trailing Stop Work?
When I first enter a trade, I attempt to calculate the amount of volatility I expect to see. I want to put my stop right at the edge of the expected volatility so that I don’t get cut out of my trade just because of wide swings. Then I calculate my max desired loss. If my max desired loss is within the range of expected volatility, then I don’t take the trade because it would just be a waste of money. If I see that I can handle the expected volatility and stay within my max desired loss I set my trailing stop at that price and set it to trail about every 10 pips. That means for every 10 pips that I win, my trailing stop will move and lock in those pips so that I cannot lose those 10 pips again. If the price drops down to my trailing stop, I will get cut out at a smaller loss than when I first set up the trade.
Insurance is a great way to protect yourself and your assets. You’ve worked hard for them, don’t let an accident take them away. A trailing stop is insurance to protect your trade and similar to auto insurance, the trailing stop can protect your assets from too much loss.
Do you use trailing stops when trading?
