There are many arguments for and against trading with a tight stop loss when trading, but forget what you have read or learnt about having a tight stop loss (for now at least), ok?
Just because you read somewhere in the internet someone saying that trading with a tight stop loss is bad does not means you shouldn’t do it.
As the saying goes:
There’s are two sides to a coin
Therefore, trading with a tight stop loss has its advantages. But to do that, you really need to understand a few things to be able to trade with a tight stop loss and here they are:
- the timing of when you buy or sell and the price that you buy or sell at is really important.
- This means that you need to have a trading system that allows you to do that and one such trading system is the trendline trading system.
- What this means is that you have to buy just when the the market is about to head up or you need to sell just when the market is about to fall.
- This means you really need to have a really good grasp and understanding of price action trading (my price action trading course is free click that link to check it out) especially reversal candlesticks.
For me, there are 7 advantages of having a tight stop loss and here they are:
#1: Improves Your Risk:Reward Ratio
In forex trading, the amount of risk you take is dependent on the length or the size of the stop loss distance, measured in pips.
For example, you risk 50 pips in a EURSUSD trade and your take profit target is 150 pips. This means your risk to reward ratio is 1:3, which simply means that should the trade turn out profitable, you will make 3 times more profit than what you risked for that trade.
If the trade is profitable, you will make $1,500. If you lose, you will lose $500 (This is for trading 1 standard contract).
Now, what if you only risked 10 pips ($100) and made 150 pips profit ($1500)? That means you have improved your risk:reward, instead of 1:3, now it 1:15!
This means that your profit is 15 times more than what you risked…
This is the first advantage of having a tight stop loss when trading.
#2: You Can Trade Large Contracts
Having a tight stop loss means you are now able to trade large contracts. How? Well, remember the example given above? Lets continue with that:
- Lets assume that you have a $20,000 forex trading account. And you want to trade 1 standard contract So if you risk 50 pips ($500), then that is 2.5% of your trading account you are risking.
- Now lets also assume that the 2.5% risk is the maximum trading risk that you use for any trade you place.
- Now, you decide to use a 10 pips stop loss instead of 50 pips stop loss. This means you are risking $100.
- $100 risk is 0.5% risk of your trading account. Your need 5 of 0.5% risk to make a total of 2.5% trading risk, right? So what does that mean?
- It means you can trade 5 standard contracts based on a 10 pips stop loss and still risk 2.5% of your forex trading account of $20,000.
You understand what I’m saying here? Well, if you are beginner forex trader, this may be a bit difficult to digest but don’t worry, you will understand as time goes on.
- if you traded 1 standard contract risking 50 pips or $500 (which is 2.5%) of your trading account and if you made 150 pips, that would equate to $1500. All you will get is ONLY $1500.
- if you traded 5 standard contracts, risking 10 pips for those 5 contracts, you still risk $500 (which is 2.5%) of your account(risk does not increase at all) and you made 150 pips. Guess what your profits would be? $7,500.
This is the second most important advantage of having a tight stop loss.
#3: Minimize Your Trading Loss
Tight stop loss also means you minimize your trading loss. In the previous example above, if you risk 10 pips, that’s only 0.5% of your trading account.
Now, lets say instead of you trading 5 lots, you only trade 1 lot at 10 pips stop loss. If you loose, you are only going to loose $100. If you traded 5 lots/contracts, you would loose $500.
So you can see here that, having a tight stop loss can minimize your trading loss, which means you do not risk a lot of your trading account in each trade.
#4: If You Are Right,You Make Profit Quickly
How good is to enter a trade and just a few seconds or minutes after you enter a trade, the trade starts to turn profitable very quickly?
Well, if you want to use tight stop loss in forex trading, it is important to be able to really get into a trade at the right time. Your trade entry price/point is most critical because that really determines if your going to profit quickly or not.
Now, lets assume that as soon as you sold EURUSD, one minute later, the price started to fall very quickly. You only had 10 pips stop loss. Guess what? You are already having floating profits.
You really don’t have to wait for market to fluctuate back and forth before you actually start to make a profit.
#5: If You Are Wrong, You Loose Quickly
Now, nobody will think of having a trade lose very quickly as an advantage…
But you see, what you fail to see is that if you place a tight stop loss and the market does not behave as expected and you get stopped out with a 10 pips loss (0.5% of your account) that is really good because now you can focus on getting another trade or look for another trade setup.
Remember, tight stop loss makes your risk:reward better.
#6: Allows You To Apply Pyramid Trading To Increase Your Profits
If you are to apply pyramid trading strategy to increase your trading profits, having a tight stop loss allows this to happen.
One main reason is due to the fact that your stop loss distance is very tight therefore it doesn’t take long for your trade to be profitable if you get your direction and trade entry timing right and therefore having a trade already in profit and a safe distance away from the entry price can allow you to take additional trades along the way using that same price trend move.
WHAT NOT TO DO
- Do not trade with a tight stop loss when you are trying to recover from a losing streak. The fear of losing another trade again will only make you trade badly and placing a tight stop loss will not help you at all, its going to make it worse…its an emotional roller coaster, believe me.
- Do not trade with a tight stop loss when a major news is about to be released, you’ll get stopped out like your mum killing the fly on the kitchen table.
- Do not trade with a tight stop loss if you do not have a trading system that allows you to do that.