Trading Without a Stop Loss
Exercising stop loss orders has been known for the most efficient manner of managing one’s risk in the market. A stop loss order enables the trader to predetermine his or her risk while reserving the rights to re-enter the market if the stop loss order is triggered due to unexpected volatility.
One of the most infamous phenomena of using stop loss orders is that shortly after the stop is hit by the market the price swiftly turns in the direction that was originally predicted by the trader. If the trader is relatively new to the market, he or she hurries to trading forums or Google and discovers the stop hunting operations that take place in the Forex market.
Although we covered stop hunting in our prior market education articles, it is an operation where a cluster of stops are targeted by the market that are heavily concentrated around a certain price level.
If stops are being mercilessly hunted by the market are they really worth using?
Double Daily Close
One of the alternatives to a stop loss order is a daily or a double daily close below the support/resistance level. Rather than layering the stop loss order in the market, the trader will have the key support and resistance levels drawn on the chart.
If the trader wishes to execute a long position, rather than using a stop loss order, if the price closes below the daily support he or she would exit the trade with a loss. Likewise, if the trader executes a short position in the market, if the price posts a daily close above the resistance he or she would exit the trade with a loss.
Some traders will seek a stronger confirmation from the market and will look for a double daily close, which means 2 candlesticks that close below the support (if a long position is executed) or above the resistance (if a short trade is executed.
The advantage of exercising this strategy is that the trader is unexposed to stop hunting operations. The trade will only be closed based on a strong technical confirmation that predicted trend has been rejected by the market.
The disadvantage of this strategy is maintaining the psychological strength to exit the market after witnessing multiple trades reversing in the predicted direction after they were manually closed following a daily or a double daily close.
The pressure will be so immense that if the trader breaks the rules and allows the trade to float, if the market reverses in the predicted direction of the trader, the immediate impression is that the same can be done to every trade.
Once the market continues to trade against the trader in future trades the drawdown may easily spiral out of control, not to mention the lethal psychological effects. If the market does not reverse and continues to trade against the trader it will be extremely difficult to pull the trade out of the market.
Trading the Margin
Another popular approach that is aimed to replace the usage of stop loss orders is managing the risk via the margin. In simple words, the trader executes small traders while maintaining a high invested capital. For example, executing 0.1 lots (10,000 units) with a balance of $200,000.
The value of each pip is approximately $1.00 so even in a scenario where the trader is down 700 pips its less than a -1.00% drawdown. Managing risk through the margin allows the trader to withstand the times the market is trading against him or her.
While it a very popular strategy, it requires a balance of at least $100,000 to be smoothly executed. In addition, the trader must also have the psychological power to close the trade with a loss. As the invested capital is hardly exposed to the market the trader may be convinced he is indestructible and may experience frequent drawdown periods.
Both stop loss trading strategies we presented may be combined together. The psychological factor however does not change and left to the mental state of the trader.
At ddmarkets we prefer avoiding the psychological adventures that are tied to these techniques. The stop loss orders we set for our trading strategies are all derived from the chart and are placed above or below deep support or resistance level that are aimed to withstand stop loss hunting operations.
We would rather have the exposure predetermined and in extremely rare events we would expand the size of the stop. We hope this article will assist you in trading the markets.
We explained in great detail how the forex signals we have been providing for over 6 years work. If you are a forex trader we recommend viewing how we carry our market strategies.