Golden Rule For Setting Stop Loss
In the forex faq today, we have a question from one of our fellow traders regarding stop loss and target profit.
Below is the question:
Hi Kelvin is there a golden rule for setting S/L
T/P ratios on different time frames.
What I am sharing with you here is what I usually do and may not be the best way to setting stop loss and target profit.
Method 1: Fixed Stop Loss Per Trade
I use the fixed stop loss per trade method for all strategy except the trend strategy. For most of my trading strategies, I will have done a back testing and therefore have gathered enough information regarding the best stop loss and target profit per trade.
For example, my back testing shows that the best stop loss for strategy (A) is 30 pips and I will always trade with a stop loss of 30 pips when I use strategy (A). I will do the same thing for the target profit for each strategy.
That is why I often insist you guys to trade the demo account first. This will allow you to record down the max draw down per trade for a particular strategy as well as the max profit per trade for a particular strategy.
Once you have these data, you will be able to decide on the best stop loss as well as the target profit.
Method 2: Previous Support or Resistance
This is by far the most common method of placing stop loss as it is taught in most forex courses or books. Using this method, you will always set your stop loss based on your previous high or low.
For example, when you are going to go SHORT after a valid trend line break. You will place your stop loss at the most recent highest point.
As for your target profit, it will usually be set at the next major support or resistance like Fibonacci extension or pivot points.
In fact, you can also use the pivot level or Fibonacci retracement as a stop loss level.
However when using this method of setting stop loss, you have to be realistic. If the stop loss is too far, you should forfeit the trade as the risk reward ratio is too low.
I will use method 2 only for trades that have a high risk reward ratio.
Therefore which way to use decide on you and there is no golden rule that you must follow when placing your stop loss or target profit.
If you are learning your strategy from a course, you should stick to the way the course creator set the stop loss. Do not try to innovate and later make things worse.