written by: Steve McFarlane•edited by: Laurie Patsalides•updated: 4/21/2011
In this article we look at some of the strategies that can used to trade Forex without a stop loss. The effect of leveraging and trend following are also highlighted as factors that can affect the success of a day trader.
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One of the secrets to trading Forex successfully is to strictly follow an effective money management strategy. For many Forex traders that means using stop losses. Unfortunately, those very same stop losses are often responsible for the failure of most day traders, especially when stop losses are tightly set. There is nothing more frustrating than having a stop loss close a trade that would have gone on to be profitable.
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Buy and Hold for Currency Traders
Trading the currency market is much like trading stocks. Despite the similarities between the Forex and stock market, most Forex traders don’t bother to employ the trading strategies that equities traders have proved over time, such as the buy and hold rule. Warren Buffet will tell you that the only way to consistently make money in the stock market is to buy shares and hold them, at least until the fundamentals change. However, good traders don’t just enter trades based on the results of some cursory technical analysis. Good traders must be satisfied that the underlying economic, fiscal and financial factors will support their trading decision.
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Be a Trend Follower
The long-term direction of a currency pair is often determined by the economic fundamentals and Geo-political realities of the country in question. These fundamentals might include the interest rate policy of the central bank, balance of payments numbers and the government's general political stance, to name a few. If a country’s economy is doing well and there are no extenuating matters, then its currency should appreciate against currencies with weaker economies.
Doing fundamental analysis like this gives a trader a long-term outlook on a currency and affords him the luxury of not taking multiple small losses, such as those that occur when tight stop losses are used. All he has to do is await for pullbacks to go long on the currency. If a trade goes negative, it can do so to a greater degree than would be possible if high leveraging was used.
However, there are exceptions to this rule. If a correction is imminent, it might be prudent to take a small loss by exiting previously negative trades and reverse positions to take advantage of the changing trend.
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Trading with No Stop Loss - Profit Protection Strategies
Stop losses don’t only exist to prevent losses but can also be used to protect profits; a good example of this is a trailing stop-loss. A trailing stop can be used to protect profits that are already on the table; this is best done when the trade has made substantial gains, and then a trailing stop can be put between the entry point and the current price action. This allows for the current price movement to continue, just in case the market will give more profits, while at the same time ensuring that the trade in question won't lose money for the trader. A ‘limit order’ can also be used to exit parts of a trade when a pullback is expected but the market has not yet hit the profit targets.
In order to avoid making large losses, many traders use tight stop-losses, but this often results in multiple small losses that can quickly add up and ruin a trading account. Often, trades that start out badly eventually become profitable, if the trade is just given some time.
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The Long and Short of It
Is it possible to trade successfully with no stop loss? The short answer is yes, but for this strategy to work, traders must only trade in the direction of the trend, avoid using leveraging/margin facilities and be bullish only on currencies that are fundamentally strong. The buy and hold strategy is not popular among currency traders, and it will never be as long as Forex brokers offer high leveraging on Forex trading accounts and traders take the bait. While the use of margin can accelerate the growth of a trading account, it is also a double-edged sword that can cause a margin call if things get out-of-hand.