Often traders experience difficulty in determining where to place a stop loss. This question is especially often raised from beginners. But it was quite surprising when the question came from a trader who had been actively trading for several months. In fact, in carrying out a forex trading strategy, a trader must absolutely apply risk management.
Place stop-loss correctly
Placement of stop-loss that is too close often ends in “tragic”, ie when the price touches the stop-loss level – really just touching, not penetrating – then then without further ado immediately reverses direction, precisely in accordance with the direction of the previous transaction position. A painful experience, so often leads the mindset of traders not to put stop-loss at all. Though this is dangerous.
There are many ways to determine the stop-loss level. In a classic way, for example, you can use support and resistance levels. To determine support and resistance there are various ways. You can take advantage of the top or valley areas of the chart that you see. To learn more details about the basics of support and resistance, you can visit our forex learning page.
In addition to utilizing support and resistance, you can also use pivot calculations, Fibonacci retracement, and others. Well, among the many methods that can be used to determine stop-loss, there is one technical indicator that you can use, namely Average True Range (ATR). This strategy is not as famous as pivot or Fibonacci, which is already popular in the world of forex trading , but it doesn’t hurt you to know this ATR method. Who knows it matches your trading style.
What is ATR?
ATR is an indicator that can function to “measure” market volatility. This indicator was first introduced by Welles Wilder in his book entitled “New Concepts in Technical Trading Systems”. Since then, this indicator has been used as a component of several other indicators and trading systems.
ATR can often reach a high value when prices are “bottom” after a sharp fall after ” panic selling “. If the indicator constantly shows a low value, the market is usually in a sideway condition. If ATR shows a significant increase, it could be a sign that volatility (possibly) will be higher.
Risk management strategy for forex trading
We mentioned earlier that we can use ATR to determine how much stop-loss we have to install.
The indicator below the chart is ATR. If you look at the part circled in the picture above, you will see the number 0.0027. That is the value of ATR at that time. This number is what we make reference to determine the level of stop-loss, and even can be used to determine the take-profit level.
The number 0.0027 means that the average price range is 270 pips ( quote the price of 5 decimal places) . In other words, if we plot ATR on the hourly chart (H1 / hourly ) with a period of 14, that means the average range in the last 14 hours is around 270 pips. Of course the calculation of the average is not simple, but through a certain formula.The rules that are applied in programming ATR indicators are as follows:
- The difference between the highest and lowest prices of a given period;
- The difference between the previous closing price and the highest price at the time;
- The difference between the previous closing price and the lowest price at that time.
As a trader, you no longer need to mess around with calculations like the above. You just have to see the last ATR value. Like the example above, the ATR value is 0.0027. To determine what level of stop-loss we must place, you just multiply that value by two. That is, by reading the ATR value as above, you can place the stop-loss level as far as 2 × 270, which is 540 pips (price quote with 5 decimal places).
Using this strategy , means that the risk-reward-ratio that you apply in your forex trading is 1: 1. Well, if you want to apply a reward that is greater than risk, you can increase the multiplier to set take-profit, for example 2.5 times the ATR value.
There are also some more aggressive traders, such as scalpers . If you are a scalper and want to use ATR to determine stop-loss and take-profit levels, you can still use ATR by dividing the ATR value by two. If the ATR value is 0.0027, then stop-loss and take-profit are placed as far as 135 pips above and below your open position level.