What is the difference between trailing stops and fixed-stop losses when trading forex and CFDs? If you trading forex or CFDs, You can use both stop-loss strategies to mitigate your losses, but have in mind that they likely have their advantages and disadvantages.
For example, trailing stops automatically lock in profits as the market moves in your favor, but can also trigger if the market reverses suddenly. On the other hand, Fixed stops are more reliable when the market is not very volatile, in this scenario, you own full control of where, when, and why you should move your stops or not. Does this sound interesting, Keep reading!
In this article, we will look into what trailing stops and fixed stop loss are all about, we will also make it simple for you to understand and chose what is better between trailing and fixed stop loss, and finally, how to set trailing or fixed stop loss when trading.
Table of Contents
- What is a trailing stop?
- What is a fixed-stop loss?
- Which is better trailing or fixed stops?
- How to set a fixed-stop loss
- How to set a trailing stop
In the financial market, a stop loss is an order that protects your account from a negative balance if the market moves against you. There are two main types of stop-losses: trailing stops and fixed stops. So, what is the difference between these two stop-loss strategies?
Fixed stops are set at a certain price level below or above the current market price which remains static regardless of market conditions. Trailing stops, on the other hand, are dynamic, They move with the market price.
What is a trailing stop?
A trailing stop is a type of order you create in trading that follows the market price of an asset as it moves in the direction of your trade. The trailing stop is designed to protect profits by allowing you to set a predetermined percentage or price level of trailing value.
The trailing stop moves in lockstep with the market price of the asset, and if the price moves against your open position, the stop-loss order will execute when the asset’s price falls below the predetermined trailing value.
For example, suppose you buy a currency pair at $1.50 and sets a trailing stop of $0.05. As the market moves in your favor, the trailing stop will move up to $1.55, $1.60, $1.65, and so on. If the market price falls by $0.05, the trailing stop order will execute, and close your trade with a profit.
What is a fixed-stop loss?
A fixed-stop loss is a risk management tool(an order) you use in trading to limit or mitigate your potential losses on a particular trade. It is a predetermined price level you set at which a position will be closed in case the price moves against your anticipated direction. The fixed-stop loss protects your account against sudden market movements that could result in large losses.
For instance, if you buy a currency pair at 1.3000 and sets a fixed-stop loss of 1.2950, the position will be closed automatically if the price reaches 1.2950, thereby limiting your loss to 50 pips. You can set a Fixed-stop loss order at a fixed price level to avoid unnecessary losses.
Fixed-stop loss orders are beneficial because they help you to manage your risk by preventing losses from spiraling out of control. They also enable you to plan your trades more effectively and limit your exposure to the market.
If you are a newbie in the financial markets or maybe you trade with smaller capital, then you must ensure that you make use of either a trailing stop loss or a fixed stop loss order, as they provide a simple and effective means of managing your risk.
Which is better trailing or fixed stops?
Well, this might be confusing for many, but the choice between a trailing stop and a fixed stop loss depends on your individual trading style, risk tolerance, and market conditions. Both approaches have their advantages and disadvantages. let’s explore!
Trailing stops are useful in volatile markets where prices can change rapidly. The trailing stop is more flexible than a fixed stop loss because it adjusts to market conditions, allowing you to capture more profit in a rapidly rising or falling market.
It also protects your trading account from sudden market reversals by automatically closing the trade at a predetermined level if the market moves against your expected direction. However, trailing stops may not work well in less volatile-moving markets, and you must be careful not to set the trailing stop too close to the entry point to avoid an immediate stop-out.
Fixed-stops are useful in markets with lower volatility where prices move more gradually. With a fixed stop loss, you will know exactly how much you are risking on each trade, which can help you in managing risk more effectively.
Fixed-stop losses are also useful if you are the type of trader who prefers to set your risk tolerance in advance and stick to it. However, fixed stop losses may result in missed profit opportunities if prices continue to rise after the stop loss is triggered.
It is important to carefully analyze or evaluate market conditions using multiple time frame analysis before choosing a stop-loss strategy and to adjust it as needed to ensure consistent profitability when trading the financial markets.
How to set a fixed-stop loss
A fixed-stop loss is a predetermined price level at which your open trades are closed to limit your potential losses. Setting a fixed-stop loss involves several steps:
- Determine your risk tolerance: Before setting a fixed-stop loss, it’s important for you to determine how much you’re willing to risk on a trade. This can be a percentage of your account balance or a fixed amount.
- Analyze the market: Use technical and/or fundamental analysis to determine where to set your stop loss. This could be based on key support or resistance levels, chart patterns, or other indicators.
- Place the order: Once you’ve determined your stop loss level, place a sell order at that price level. Placing the order ensures that your trades will exit if the market moves against your position and reaches your stop loss level.
- Monitor the trade: Keep an eye on your trade to ensure that your stop loss is triggered if the market moves against your position. If the market moves in your favor, you may want to consider adjusting your stop loss to lock in profits or to break even to avoid losing money on the trade.
How to set a trailing stop
A trailing stop is a dynamic stop-loss order you can utilize to protect your trailing profits while allowing trades to continue to run in the event of price movements in your favor. You can set a trailing stop through the following these steps:
- Determine the appropriate distance: The first step is for you to determine how far or close the trailing stop will be from the entry price. This is often based on your risk tolerance and the volatility of the market.
- Set the order: Once you determine the stop distance, you can then set a trailing stop order in your trading platform. You can do this by selecting the order type and entering the appropriate distance from your trade entry price.
- Monitor the trade: As the trade progresses, the trailing stop will automatically adjust itself to maintain the specified distance from the current market price. You should also monitor the trade and manually adjust the trailing stop if necessary.
It’s important to note that while trailing stops can protect your profits and limit losses, they do not guarantee success in trading. Proper risk management and strategy development are also important factors in achieving trading success.
Now, both trailing stops and fixed-stop losses are essential risk management tools for traders in the forex and CFD markets. While trailing stop losses provide a straightforward approach to risk management, fixed-stop allows you to adjust your stop-loss orders in response to changing market conditions.
You can use trailing stops to lock in profits and limit losses, while fixed-stop losses provide a level of certainty in the maximum loss a trader is willing to take. Ultimately, the choice between trailing stops and fixed-stop losses depends on your individual trading style, risk tolerance, and market conditions.
It is essential to note that neither trailing stops nor fixed-stop losses can guarantee profits or protect you from all potential risks. Therefore, you should always use risk management tools alongside a well-defined trading plan and strategy to ensure long-term success in the forex and CFD markets.
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“Chikwem Chinedu Ogugua is a Trader | Content writer | Entrepreneur| With a passion for educating others about the financial markets. Through his writing, he works tirelessly to share insights and knowledge gained from years of experience trading in the financial market. He is dedicated to helping others achieve success in their journey by providing valuable information on what works and what doesn’t.