Discipline, Strategy and Tolerance
Successful traders are not just traders who take the best positions but they are also diligent about managing risk and are extremely disciplined in their strategy. Such traders are devoid of emotion with regards to their gains or losses. Based on their trading strategy; they set a profit target and loss limits for their positions, and use Limit Orders and Stop Loss Orders to lock them in.
It should be noted that professional traders will rarely leave their trading desk as they want to ensure they can act on any significant news or market volatility. That said, to remove temptation (taking profits too early and allowing losses to run) and keep a disciplined approach, successful traders will ensure they manage their risk by using Limit & Stop Loss orders.
Limit Orders Explained
Regardless of what Broker you are trading with, and the various trading platforms they offer, the explanation, and rules, around Limit Orders are standardized throughout the market. Simply put a limit order is an order that sets the maximum price you are willing to buy an instrument at, or conversely, the minimum price you are willing to sell an instrument at. The advantage of such an order is that it guarantees that your trade will be executed at a specified price or better. Such orders are used to both enter and exit a position at predefined levels per your trading strategy and your risk/reward parameters. It is important to be aware that Brokers will “treat” Limit orders differently. For the most part you should be “filled” at your executed price or better but, depending on your broker’s execution model, you may find that only part of your order is “filled”. It may sound strange but some brokers may offer you to treat your Limit order as a Market order once your limit price has been “touched” then the price you are executed at may be worse than intended. So, as we continually recommend – check with your broker beforehand so that you will not have any nasty “shocks”!!
Stop Loss Orders Explained
As the name implies a Stop Loss order allows you to “Stop losing” more than you are willing to. Your trade will only be executed when the instrument you are trading reaches a predefined price (the stop price). Once the market reaches your Stop price your order becomes a market order and is executed at the prevailing market rate. As we mentioned above, Stop Loss orders are particularly useful for traders who may be away from their trading platform so as to ensure they minimalize their downside risk. Be warned!! As we explained above once your Stop Loss has been “triggered” your order becomes a “market” order. There can be times, such as during high impact news and/or economic data releases, when the market moves rapidly and spreads can widen. In such times you may find your Stop Loss being “filled” at a much worse price than you anticipated. Your broker should be able to give you an idea of their “typical” spreads after major data releases but we would recommend reviewing your brokers spreads yourself so as to avoid any major surprises! You may have a broker that offers a “Guaranteed Stop Loss Order” (GSLO). With a GSLO you will be executed at the price you set – the “catch” is that you will pay a premium to your broker for doing so. These premiums can vary depending on the instrument you are trading, your trade size, time of day etc. so again, if you need more information ask your broker.
Successful professional traders will often utilize Limit Orders and Stop Orders as the cornerstone of a disciplined trading strategy. In many cases these are the dynamically changing Stops and Limits invisible to the broker. Placing Limits and Stops on all positions removes emotion from the equation and allows the market to work for them. New traders, on the other hand, do not use Limit Orders and Stop Orders. These traders are “glued” to their trading screens, trying to manage all of their open positions in real time. Invariably they will miss critical action points and let emotion rule their decisions.
Where to Enter & Exit?
Where you place your Limit and Stop Orders will depend on both your trading strategy and risk tolerance. But it is important to be sensible about where you place them regardless of your strategy. A Stop Loss Order that is placed too close to the entry price will likely get “filled” with normal market volatility. In other words a market “blip” can result in a position being closed before the market has a chance to re-balance or retrace. In the same way a Limit Order that is set too far away from the current market price may result in your order not being executed and your strategies potential profit may never be realized. Another important factor is the risk reward ratio your strategy and risk tolerance is designed for. Simply put, if you are willing to lose 20 pips on a trade how much are you looking to make? The answer depends on your strategy and risk tolerance but it should never be 1 to 1. Think about it you are prepared to lose as much as you make? In the long run you will never see your equity grow. Ideally your risk reward ratio should be 2:1, 3:1 or 4:1 (truthfully you can adopt any risk reward ratio that your strategy and risk tolerance dictates). So if you are willing to lose 20 pips on a trade then you should be willing to make 40 pips (2:1 ratio). A 4:1 ratio would result in a potential 20 pip loss versus an 80 pip gain. Again, you need to discover what risk reward ratio best suits your trading strategy and your own risk tolerance levels.
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