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How Is a ‘Stop−Loss' Order Different in Forex?

Thu, Jun 29 2006, 11:55 GMT
by Osman Ghandour

The Forex Edge

How Is a 'Stop-Loss' Order Different in Forex?

A casual browsing of currency brokers’ platforms reveals an inescapable message. Forex is different from other markets such as stocks and commodities in many ways. The list of what distinguishes the currencies is extensive. However, what you will not find included in the list is the function of stop loss orders.

At first glance, it does not seem that this area needs exploring. What of an order that attempts to limit a loss or prevent a profit from turning into a loss? Its function is known. End of story; Not so fast.

When a stock trader executes a buy order, he deposits at least 50% of his purchase. If a Forex trader also deposits 50% of his purchase, there would be no need to distinguish between their stop-loss orders. But in most cases, the Forex trader is more leveraged (at times close to 100-to-1); so a certain adjustment needs to be made in placing a Forex stop-loss to accommodate for the extra exposure.

There is also a difference in the technicals. In stocks, participants tend to cluster around levels outside formation boundaries or defined by clear support or resistance parameters. At times, that is workable because stocks usually move a few percentage points at a time. In this situation, even if you are at maximum allowable stock leverage, your loss is still manageable since the largest portion of your assigned capital is still available.

If no leverage is used, the loss has even less of an impact. By the same token, when a Forex trader buys a currency lot and deposits the full amount of $100,000, the currency fluctuation is likely to have a minimal impact. In this case, the application of a stop loss order based on support and resistance would be adequate. But currency traders are not known to deposit the full amount of their position.

In commodities, stop loss orders are sometimes misnomers. That is because commodities can move the limit, meaning there can be no ‘exit door’. A recent example happened in the Cattle market when the mad cow disease surfaced in the US in late 2003. Had you been long cattle futures, you would have been locked in for three consecutive ‘limit down’ days.

Given these disparities between stocks, commodities and Forex, the Forex trader needs to approach the function of stop loss orders from his unique perspective. And because each different leverage position demands its particular considerations, there is no ‘one size fits all’.

The one concept flexible enough to satisfy most conditions pertains to placing stop-loss orders based on dollar amounts. As such, where a position is exited will have a direct relevance to each individual trader’s circumstances, irrelevant of market conditions. If a Forex trader takes a position at 100-to-1 leverage, it makes no sense placing a stop-loss order at some support level that is 2% away from his entry.


One cannot lose sight of the fact that if one loses 50%, one needs to double the money to come back to even. If traders insist on looking for support or resistance parameters to place protective stops, they need to lower their leverage to 20-to1 or less.

Published on  Thu, Jun 29 2006, 06:55 GMT

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