Frequently getting stopped out even when your trading direction is correct? This article will help you place stop losses more effectively to avoid this issue. Placing a stop loss is one of the most misunderstood and neglected concepts in trading. Understanding how to set stop losses correctly is crucial to minimizing losses.
The Importance of Wider Stop Losses
Many traders tend to place their stop losses as close as possible, believing that a tighter stop loss will reduce the risk per trade. However, this belief often stems from a misunderstanding of position sizing, risk/reward ratios, and proper stop loss application. A stop loss that is too close often results in being stopped out even when the trade direction is correct.
Note One: Position Sizing
One common mistake is the belief that a closer stop loss will reduce transaction risk. Many novice traders think that a small stop loss distance means smaller transaction risk. However, the risk per trade is actually determined by position size or trading volume, not stop loss distance.
For example, on the MetaTrader platform, transaction size is set in the "volume" tab. The larger the volume you input, the greater the transaction risk you face.
Case Examples:
- Position 1 EUR/USD, stop loss of 120 pips with a lot size of 0.1, risk is $120.
- Position 2 EUR/USD, stop loss of 60 pips with a lot size of 0.2, risk is $120.
Despite different stop loss distances and lot sizes, the risk per trade can still be controlled. A wider stop loss does not automatically increase transaction risk if lot sizing is done correctly. The main advantage of a wider stop loss is a larger profit target, allowing you to achieve a more balanced risk/reward ratio.
Why Use Wider Stop Losses?
Wider stop losses give the market room to move. Often, trading positions that align with market direction are stopped out first due to a too-close stop loss. The market can be very volatile without warning. It is a trader’s responsibility to factor in this volatility when placing stop losses. One useful indicator is the Average True Range (ATR), which shows the average daily price range.
Applying Wider Stop Losses
For example, if the EUR/USD price movement is 1% (100 pips) or more per day, placing a 50-pip stop loss does not make sense. You need to set a stop loss larger than the ATR of the last 14 days (the average daily range over the past 14 days).
Chart Examples:
Two charts below show EUR/USD with an entry buy signal on a pin bar pattern but with different stop losses. The second chart has a wider stop loss.
- The first chart shows a smaller stop loss.
- The second chart has a wider stop loss.
These charts clearly show that a wider stop loss allows you to stay in the market until it clearly indicates that you are wrong. You do not need to spend all day in front of the chart. This trading style allows you time to learn and focus on finding the best setups. You can identify trends and observe price movement patterns in more detail.
The Importance of Wider Stop Losses
Wider stop losses enable set-and-forget trading. If you need time to relax, you can do so while the market is sideways. You just use a wider stop loss and adjust the size/volume of your trades to keep the risk per trade within money management rules.
Many traders fail in the long term for two main reasons: overtrading and stop losses that are too tight. With a stop loss that is too close, you will frequently get stopped out even if your trading setup is good. Simply use a wider stop loss and adjust the size/volume of your trades to maintain risk per trade according to money management rules. Understanding and applying the right stop loss strategy helps manage trading risk and increases the chances of long-term success.
Happy trading and good luck!
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