A Stop Loss is an order to close a trade when the market moves a specified amount against the position. For example, if a trader longed EURUSD at 1.2500 and was only prepared to lose 15 pips, a stop position would be set at 15 pips below the current market price at 1.2500 – 0.15 = 1.2485.

The purpose of setting up a stop loss order is to put a “safety net” on transactions. Without a stop, a trader could potentially lose all his funds if the trade went against them. A stop position reflects a trader’s “pain point,” where the market has turned so far against him that he needs to exit his position. As a result, stop orders are useful for money management in controlling losses, helping to ensure a trader is controlling their risk exposure.

Stop-Loss Caveats

A frequent mishap with stop placement however, is that traders too often place their stop orders directly on key support/resistance levels. The rationale for this is understandable, support and resistance areas where price action usually stalls – thus if the markets moves to that level it is unlikely to trade through. But it is not uncommon to see the market trade down to key support levels and then reverse back in the trader’s favor. Whether the source of this frequent misfortune is Interbank FX dealers or trader psychology – stops are often better place just beyond such key support/resistance levels.

OCO – One Cancels the Other.

One Cancels the Other (OCO) orders are the norm with stop-losses and limits. With an open position, a trader may have attached a limit as well as a stop and trailing stop. After a position is closed by a limit, what is there to prevent the leftover stop from remaining, waiting to be executed? If they are OCOs, then when the limit is executed the stop will be canceled – if the stop is executed the limit will be canceled. This ensures there will be no ‘leftover’ orders after a position is closed.