Stop loss is used only with open positions. When the market conditions are not favorable for a trader and the price has reached the level of the "Stop loss", the deal is closed automatically. Therefore, Stop loss helps the trader to control losses and in case of failures to keep safe at least part of his deposit.
If a trader does not use Stop loss orders, the position is closed by the broker when the sum of losses is equal to the sum of the deposit.
There are 3 types of Stop loss orders:
- fixed Stop loss,
- sliding Stop loss and
- combined Stop loss.
Fixed Stop losses are set while opening positions. They cannot be changed until the deal is closed.
Sliding stop losses, on the other hand, can be modified any time depending on the price movement. Another name for sliding Stop loss is Trailing stop, that can be modified either manually or automatically based on the traders' settings.
There are many discussions on whether it is necessary to use Stop losses or not. Some traders believe that Stop loss is essential in trading, emphasizing the ability of Stop losses to prevent the loss of the whole deposit. If the price is rapidly moving in a direction which does not correspond to the forecast, a deal that has not been closed in time can result in a significant loss.
The opponents of Stop loss believe that this order can limit not only losses, but profits as well. Since price movements are often unpredictable and unexpected, they can develop in line with the trader’s expectations, though with some periodic bounces crossing the Stop loss line. In this case the position is closed prematurely with a loss while it could develop into a profit later on.
As a rule, the decision on whether to use Stop loss or not depends on the individual strategy and preferences of a particular trader.
Trailing stop is an order which its major function is to act as an automatic maintenance of an open position with continually shifting of the stop loss level depending on the price movement.
A trader may open a bullish position and sets the gap from the current price to trailing stop in pips. When the price goes upwards, the trailing stop follows it automatically sticking to the set gap. In case that the price goes down, then the trailing stop quote remains on the spot. In this way, a trader using a trailing stop has an opportunity to derive maximal profit at an ascending price with no regard to the set Take Profit value. Furthermore, a trailing stop is a loss limiter.
Here is an example: a trader opens a buy position at the price of 1.3400 and puts the trailing stop value at 50 pips back, i.e. at 1.3350. In case that the price starts to move upwards and exceeds the mark of 1.3400, the trailing stop follows it automatically keeping the set gap of 50 pips from the current price. That means, if the price touches 1370, the trailing stop shifts to 1320. If the price turns down, the price does not change its position.
As to a sell position opening, trailing stop behaves quite in the opposite. The trader sets it a few pips higher. At a price descending motion the trailing stop shifts according to the set size. With the up-going price, the trailing stop does not move.
While applying a trailing stop in Forex operations a trader will have to remove stop loss orders manually in line with increases in the trade profit. Trailing stop sets a stop loss level automatically at the value the trader needs.
A trailing stop is mainly used by traders who run trend trading, but can't follow the price moves continually. Trailing stop usage is also feasible at intraday trades, when quick reaction to price change is required.
Please note that trailing stops work only when the trading terminal is open. Once the terminal is switched off the stop loss is fixed at its current spot.