Stop Orders and Limit Orders: How to manage forex trading risk

Stop Orders and Limit Orders are your best friends in forex trading. Use them to manage the reward/risk ratio you adopt from the beginning. Stop-Loss and Limit Orders help you overcome a natural tendency to “trade on emotion” and help you practice good money management.

 

In this in-depth guide you’ll learn:

  • What is the difference between Stop Orders and Limit Orders?
  • How do Stop Orders and Limit Orders work?
  • What is a Stop Order?
  • What is a Limit Order?
  • What is the golden rule of forex trading?
  • Are Stop Orders and Limit Orders safe?


And lots more…

Let’s dive right in…

 

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👉 The biggest mistake beginner forex traders make is reacting emotionally to trading decisions. Many forex traders are unsuccessful because they make irrational decisions to open or close a position, stemming from fear and anxiety or over-excitement and overconfidence.

 

👉 For beginners, you will learn to develop a strategic trading plan in a forex trading course. Still, real-time trading will test your ability to control your emotions, maintain trading discipline and stick to your trading plan.

 

What is the difference between Stop Orders and Limit Orders?

👉 Stop Orders and Limit Orders are examples of Pending Orders, meaning buy and sell orders are executed later at a pre-determined price. Market Orders are executed instantly at the best price provided by forex brokers.

 

👉 Pending Orders are automated instructions to execute trades when prices rise or fall to a certain level. Pending Orders allow traders to open and close positions without sitting at their desks and continuously monitoring currency pair price movements.

 

👉 Stop Orders and Limit Orders are placed on trades executed on electronic trading platforms such as MetaTrader 4, MetaTrader 5 and cTrader.

 

How do Stop Orders and Limit Orders work?

👉 Retailer traders place Stop Orders and Limit Orders on long and short positions that are opened on electronic trading platforms used to access the forex market. Orders are instantly sent to the relevant exchanges and recorded on automated Order books.

 

👉 Stop Orders and Limit Orders remain active until the orders are triggered, cancelled or expire. Traders specify an order validity period at the same time. Orders automatically expire if they are not triggered by Stop or Limit Orders or cancelled. A “Good-Til-Cancelled” (GTC) order means the order remains active in future market sessions until it is triggered or cancelled.

 

What is a Stop Order?

👉 A Stop Order is a trading order executed automatically when a specified price is reached. Stop Orders are used to enter new positions or exit current positions. A Stop Order is also called a Stop-loss Order because it is used to limit losses.

 

Stop Orders provide automated instructions to buy or sell when assets reach a price point beyond what traders are willing to tolerate losses.

 

There are two types of forex Stop Orders:

 

1️⃣ Stop-buy Order

A Stop-buy Order means assets are bought as soon as the price rises above a pre-determined Stop price.

 

2️⃣ Stop-sell Orders

A Stop-sell Order means assets are sold as soon as the price falls below a pre-determined Stop price.

 

Why do forex traders use Stop Orders?

Limit losses

👉 Stop Orders are used to minimise losses in forex trading, meaning Stop Orders help reduce the size of losses. Traders know where they want to exit forex positions based on the reward/risk ratio they adopt and set Stop Orders to close positions automatically at pre-determined price points. Stop Orders help traders stick to their trading plan and avoid trading on emotion.

 

Safeguard profits

👉 Stop Orders are used to safeguard profits for long and short positions. Traders move Stop-sell Orders on long positions that are very profitable to protect their gains. They move Stop-buy Orders that are not profitable to save some of their profits.

 

Trade forex breakouts

👉 Stop Orders are helpful to trade breakouts when prices move above resistance areas or move below support areas. Breakouts signal the likelihood of prices starting to move in a potential trending direction.

 

👉 Forex traders set a Stop-buy Order a few pips above the resistance area to take advantage of upside breakouts. Traders open long positions if the price reaches or surpasses prices specified in Stop-buy Orders.

 

👉 Entry stop orders are used for trading downside breakouts. Forex traders set a Stop-sell order a few pips below the support area. Traders open short positions when prices reach or surpass prices specified in Stop-sell Orders.

 

What is a Limit Order?

👉 Limit Orders are used when traders want to open a new position or close a current position at a pre-determined price or a better price. The order is automatically executed if currency pairs trade at that specific price or better.

 

👉 Traders set limits based on the reward/risk ratio adopted and either buy below the current market price at a specified price or sell above the current market price at a specified price.

 

There are two types of Limit Orders:

 

1️⃣ Limit-buy Orders

Limit-buy Orders are automated instructions to buy currency pairs at the market price only when prices reach specified price points or fall lower.

Limit-buy Orders mean orders are triggered when currency pair prices are equal to or LESS than specified price limits placed on orders.

 

2️⃣ Limit-sell Orders

Limit-sell Orders are automated instructions to sell currency pairs at the market price when prices reach specified price points or rise higher.

Limit-sell Orders mean orders are triggered when currency pair prices are equal to or MORE than pre-determined price limits placed on orders.

 

Why do forex traders use Limit Orders?

Fade breakouts

👉 Limit Orders are used by forex traders who enter the forex market to fade breakouts. Limit Orders are a contrarian trading strategy, meaning traders oppose or reject popular opinion and take opposite positions on a trend.

 

👉 Traders fade breakouts when they do not expect currency prices to break past the market’s expectations, usually following breaking political or economic news. Traders expect currency prices will bounce off the resistance areas and go LOWER or bounce of the support areas and go HIGHER.

 

👉 Traders place Limit-buy Orders on long orders a few pips above support levels. Long orders are triggered when prices fall to pre-determined price points or lower.

 

👉 Traders place Limit-sell Orders on short positions a few pips below resistance areas. Short orders are triggered when prices move up to pre-determined price points or higher.

 

Safeguard profits

👉 Limit orders are used to protect profits. Traders know where they want to take profits if the market moves in the wrong direction, meaning contrary to popular opinion. Traders can automatically exit the market based on pre-determined profit objectives.

 

What is the golden rule of forex trading?

👉 The golden rule of forex trading is STICK TO YOUR TRADING PLAN.

 

👉 Trade currency pairs using Stop Orders and Limit Orders to avoid making emotional trading decisions. You can move Stop Orders and Limit Orders in your favour to lock in profits but setting Stop Orders and Limited Orders at the beginning of trading sessions is key to a disciplined trading strategy.

 

👉 Your trading plan is based on the reward/risk ratio that suits your trading philosophy. Forex traders determine the amount of risk they are willing to take for potential profits before entering the markets. The financial reward has to measure up or exceed the risk of trading currency pairs on the forex market.

 

What is a reward/risk ratio?

👉 A reward/risk ratio is the measured difference between a trade entry point and exit point and the potential for gains or losses. Equal potential profit and risks are represented as 1:1; two units gain to one unit potential loss is represented as 1:2.

 

Risk/reward ratio of 1:2

Traders are willing to risk $1 for an expected return of $2.

 

Risk/reward ratio of 1:5

Traders are willing to risk $1 for an expected return of $5.

 

How do you calculate the reward/risk ratio for forex trading?

👉 Before entering positions, traders set upside and downside targets based on current market prices. Upside and downside targets are determined using technical and fundamental analysis to identify potential price movements on currency pairs.

 

They use the following formula:

Reward/risk ratio = total profit target divided by the maximum risk price

 

Are Stop Orders and Limit Orders safe?

👉 Stop Orders and Limit Orders are simple trading tools that lock in profits and minimise excessive losses when trading currency pairs on the global markets. Stop Orders and Limit Orders are beneficial for inexperienced beginners who tend to buy and sell forex on emotion.

 

👉 The main risk associated with Stop Orders and Limit Orders is they guarantee price limits, but, in many instances, trades are not executed at the desired price. In volatile trading conditions – a fast market – forex traders suffer losses when stop orders are triggered but limit orders are not filled before market prices smash through resistance and support areas.

 

FOREX TRADING AFRICA DISCLAIMER

Forex and CFDs are complex instruments, and trading these instruments come with a high-risk warning. Trading forex and CFDs involves a high risk of losing money rapidly due to leverage and margin. You need to understand how forex trading works and decide whether you can afford to take the risk of losing money on trade orders that do not go your way.

 

Forex Trading Africa annually reviews brokers and financial instruments and provides information to help traders and investors make better decisions when trading on global markets. The information is published to help improve your knowledge and understanding of international multi-asset trading and market participants.

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