Let’s start off with the most basic type of stop: the percentage-based stop loss.
The percentage-based stop uses a predetermined portion of the trader’s account, say 2%, that a trader is willing to risk on a trade.
The percentage risk can vary from forex trader to forex trader -more aggressive ones risk up to 10% of their account while less aggressive ones usually have less than 2% risk per trade.
Once the percentage risk is determined, the forex trader uses his position size to compute how far he should set his stop away from his entry.
This is good right?
A trader is putting a stop, which is in accordance with his trading plan.
This is good trading right?
You should always set your stop according to the market environment or your system rules, and not how much you want to lose.
We bet you’re thinking right now, “Huh? That doesn’t make any sense. I thought you said that we need to manage risk.”
We agree that this sounds confusing, but let us explain with an example. You remember Newbie Ned from your Position Sizing lesson don’t you?
Newbie Ned has a mini account with $500 and the minimum size he can trade is 10k units. Newbie Ned decides to trade GBP/USD, as he sees that resistance at 1.5620 has been holding.
As per his risk management rules, Ned will risk no more than 2% of his account per trade.