How to Set Stop-loss Orders in Currency Trading?

How to Set Stop-loss Orders in Currency Trading?

Reading time: 7 minutes

Are you thinking about trading in the foreign exchange market?

Wondering how traders mitigate downside risk?

This article sheds light on what a protective stop-loss order is, why it is important and how to set it up in your MetaTrader trading platform.

What is a Protective Stop-Loss Order?

A protective stop-loss order is a predefined level designed to help provide the trader and the investor with a means of limiting risk exposure in both long (buy) and short (sell) positions. A protective stop-loss order remains active even when you are away from the trading desk or you are offline and is often the first port of call for a trader and investor regarding risk management. This is not only true in the Forex market, it is true for trading in stocks, commodities, cryptocurrencies and just about any tradeable instrument in the financial markets.

To grasp a deeper understanding of the protective stop-loss order, one must also understand the bid and ask price levels. For traders, the bid price reflects the value at which a currency pair can be shorted; conversely, an ask price represents the market price at which traders can long a currency pair (as a note, it is always the base currency that is traded). Together, bid and ask prices form the bid/ask spread.

In a long position, a protective stop-loss order is set below the market price and will automatically liquidate the trade at the predefined level (the stop level) once the bid price (a trader's sell price) hits the level. It is the same for a short position; only the protective stop-loss order level is above the market price and will be liquidated at the next available price once the ask price (remember, this is the price traders can buy at) has hit the level.

One of the key benefits of using a protective stop-loss order is that it can reduce emotion-driven mistakes; the trader predefines their risk before entering the trade.

How to Set a Protective Stop-Loss Order?

Fortunately, setting a protective stop-loss order in either the MetaTrader 4 (MT4) or MetaTrader 5 (MT5) trading platforms is straightforward. 

Assuming you are working with an MT4 platform (it is similar to MT5) and, in order to demonstrate how a stop order is set, let’s suppose your analysis and current market conditions have helped identify a possible short-term shorting opportunity on the USD/JPY currency pair. 

The first step involves opening the Order Window, as shown in Figure 1. You can do this by either right-clicking on the Trading Terminal (CTRL + T) and selecting ‘New Order’ or simply pressing F9.  

From this tab, you are required to input trade specifics according to your research. As the research has identified a selling opportunity, the protective stop-loss order will be above the current price (¥150.052) at ¥150.13, with a take-profit order set at ¥149.92 (a profit target set at obvious lows). This is a short-term sell trade, and therefore, the trader decided that a market order would be suitable for their needs: an order that will be filled at the next available price. As a result, by clicking ‘Sell by Market’, the order will automatically feed through to FP Markets, who will fill your order at the next available price. 

Figure 1

In this case, as seen in Figure 2, the trade was filled at the current market bid price of ¥150.053 with little slippage (difference in the desired price and the price the order was filled).

Figure 2

it is important to note that when you sell at the bid, in order to exit the position, an order will be filled at the ask price. This is the reason a short position begins with a floating loss (unless the bid/ask spread is equal), as the current trading price seen will be the ask price. This is similar to a long position. Although you would buy at the ask price level, to exit the position, the trader would sell the bid. 

Trailing Stop?

For those who want to implement a trailing protective stop-loss order—an order that operates as a traditional protective stop-loss order but is designed to trail a favourable position by a predefined number of points and remain in position once price movement begins to pullback—you can do this by right-clicking an active order and selecting Trailing Stop. From here you can determine the number of points you wish the order to be trailed by. As a note, one point reflects 1/10th of a pip. 

Final Words

Risk management is a crucial element in trading Forex, and setting a stop-loss order is one of the primary steps to mitigating risk. How one determines their stop-loss level will be unique to their Forex trading strategy. Adopting a technical stop is common; this is an approach that involves the use of technical analysis: support and resistance levels, for example. Some traders also use volatility indicators, particularly in volatile markets to help position a stop order, such as the Average True Range (ATR) or even Bollinger Bands. 

Consider opening a demo trading account with FP Markets and begin exploring how to use a protective stop-loss order in your trading.