Forex & the Big Mistake

By: Martin Bottomley

One of the biggest myths in foreign currency trading is that price is predictable and that for every level that price has visited, it will revisit that level again.

If you are a regular reader of my articles, you will be aware that as the result of my trading system support service, I get asked a lot of questions.

One particular question that I am asked on a fairly regular basis is - "Do I really need to use a stop loss? After all price always returns sooner or later doesn't it?"

Well no actually, it does not, but I can see why I am often asked this question.

Price is very capricious. Price loves nothing better than to lead us traders into a false sense of security, take all of our hard won money, and then to smile sweetly over it's shoulder as it waves us goodbye.

What do I mean by this?

A recent question that I received sets the scene quite nicely:-

"Why is it necessary to set a stop loss? I have been setting stop losses as detailed in the trading system, but I find that sometimes I get stopped out and then price moves back in the original direction and makes a lot of pips. Even when price runs against me it nearly always comes back".

Did you spot the dangerous word in that question?

It is a strange phenomenon that we traders fool ourselves into believing something to be totally true, when in fact it may only be true most of the time, and in trading, this could be a very costly mistake.

Well, if you haven't guessed, the dangerous word was "nearly".

You see, if price ALWAYS came back, we could - given deep enough pockets - hold on in there, watching our losses grow, but certain in the knowledge that sooner or later we would see those losses reduce and then turn to profit.

This does happen quite often, but quite often is not often enough because if we are prepared to let our loss run, at some point the loss will keep on increasing until we are completely out of funds, at which point we will be forced (possibly by a margin call) to liquidate our position and this will likely more than wipe out the other times when we profited from price making a return to the levels that we had hoped for.

Price can come back nearly every time, but it only has to fail to do so once to wipe you out if you do not use a stop loss.

Setting a stop loss is a very sensible and essential thing to do.

Setting a stop loss should be an intrinsic part of your trading method. You should be in the habit of setting your stop loss on every single trade, at the same time that you place the trade.

Selecting your stop loss position is something that should be calculated prior to the placement of your trade, and you should at that time also consider the amount that you are about to place at risk in relation to your money management objectives.

Sure, sometimes you will get stopped out for a small loss and price will then carry on in the direction that you had hoped, leaving you on the side lines. On these occassions you will not gain all of those pips of profit.

In the long run though, setting your stop loss will keep you in the game, and staying in the game will allow you to make your profits from the many times when price moves just the way that you want it to.

Foreign Exchange
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