This article looks at the different stop loss orders and answers the question of which is more effective when FX trading.
Due to the volatility of the foreign exchange market, all trades present with a certain degree of risk. In order to be an effective trader you need to account for this risk when FX trading. This can be done by implement a risk management plan into your trading strategy, with the most common form of risk management being the use of stop loss orders.
The stop loss order is designed to limit the amount of capital a trader can lose if a trade goes bad. It does this by exiting the position once a specified price, which is below the purchase price, has been reached. For example, a trader may enter a long trade at 4,000 and place a stop loss at 3,950. If the price falls and reaches the stop loss price, the trade will be closed and the loss will be limited to 50 points. As can be seen, the stop loss order is the difference between a loss and an account depleting loss.
The stop loss market order
There are two types of stop loss orders – the stop loss market order and the stop loss limit order. The stop loss market orders are stops that use stop market orders as the underlying order type. They are set at a specific price that will be executed as a market order if the market price reaches the stop price.
The unique feature of this type of order is that it will always be filled and the trade always exited. This is due to the fact that market orders are always filled. However, market orders are filled at the best available currency price, which means the stop loss can be filled at any price beneficial or not.
The stop loss limit order
The stop loss limit orders are those used as risk management tools with the stop limit orders being their underlying base. These stops are placed at specific prices, and if the market price hits that stop price the order will be exited and closed.
Limit orders are filled at the order price; therefore a stop loss order will only be filled at the stop loss price. Unlike market orders, these orders will not be filled each time meaning that a trade may not be exited according to the stop loss limit.
Which is better for FX trading?
The purpose of a stop loss order is to exit a trade, and the stop market order is the method that will meet this requirement continuously. The additional losses one may face from disadvantageous fills are reduced when using a stop market order when compared to the loss one may experience if the trade is not exited at all. Furthermore, the potential for this adverse order fill can be avoided by placing the stop loss at obscure prices (prices uncommon to other traders).
As a conclusion, there are situations whereby a stop loss limit order would be best. However, it is recommended that all trades on the FX trading market utilise a stop loss market order to exit a trade completely.