After having identified your entry on a new trade, the next step should always be to identify the price level for your protective stop.
The difference between the entry and the protective stop is your risk and represents what you are willing to lose on the trade. Too many new traders use what they call a “mental stop”. They have a price level in mind where they would consider getting out if the market moves against them, but do not enter it into the trading platform. Typically, when the market does move down to that price, instead of exiting, they “wait and see how the market will react”. If the loss becomes larger, they then decide that they will exit when the market moves back to their original mental stop level. As the market continues to move against them, intentions about getting out turn to hope about the market coming back before they get a margin call. Many times, it is that margin call that determines their exit, not their own analysis. Sound familiar? I hope not, but this happens more than it needs to in the world of currency trading. You can avoid this by simply placing a protective stop in the market with your entry, which means you have identified and limited your loss to an amount that you have determined to be acceptable. A losing trade does not mean the trader does not know how to trade and is not something we can avoid by not using protective stops. We should instead limit those losses with the use of a protective stop. This way we can make sure we have protected our account balance and still have enough funds to take advantage of the next trading opportunity. We should judge our success by the results of a series of trades, not just one trade. Without identifying our risk and using a protective stop, we risk not having the funds to be around long enough to take advantage of a series of trading opportunities. By using a protective stop in every trade, we can help to keep this from happening.
Written by Dailyfx.com