Challenging conditions in the financial markets put increasing pressure on traders, and faced with such circumstances, they find themselves needing to adjust risk parameters. In line with this, it is important nowadays for every trader to know how to use stop loss and leverage while trading, in order to always approach trading professionally.
Brokerages offer a wide range of features, including platforms like MetaTrader 4, which come in hand with risk management tools and also let each user choose their desired leverage level. Let’s take a deeper look at some of these concepts.
Alt-text: understanding stop loss and leverage
How to properly use a stop loss
Fundamentally, stop loss is your safety net. Once it’s set on an open trade, it determines at what price level the trade will be automatically closed. When trading online, traders deal with probabilities, which makes the outcome uncertain. Regardless of your strategy, it is impossible to anticipate all market moves correctly all the time, and the stop loss can save you when the price does not behave as expected.
As a rule of thumb, it would be better to set the stop loss right when you open a trade. In terms of its placement, there are numerous approaches. Some traders choose to set a fixed stop loss on all trades (50, 100, 150 pips, etc.). Others believe that it should be placed below/above support/resistance levels. In that case, when the price reaches the SL, you will have a confirmation that it’s time to get out of the market, trimming the loss.
Leverage
When it comes to leverage, it basically means how much you can borrow from your broker in order to place larger trades. For example, a 1:100 leverage will provide you with 99 units, regardless of your account currency, for each 1 unit you have deposited.
At first glance, it does seem attractive, yet leverage acts as a double-edged sword. True, it can increase returns, but it can also do the same to losses. Is the leverage level relevant? Yes, but to a limited degree. Regardless of how you set it, the main point is to always use a small amount of the disposable account margin. This brings us to the next topic, which is risk management, which is now very critical since stock markets, commodities, and bonds are now very volatile.
Incorporating these tools into a risk management system
You should be thinking about stop loss and leverage not as isolated variables, but as part of a broad risk management set of rules. For instance, the stop loss should be placed in such a way that in every trade you are aiming for a larger take profit, so the ratio between SL and TP (risk/reward ratio) should always be higher than 2.
Position sizing needs to be calculated based on your account balance and the stop loss needs to be placed so you are risking a predefined amount on every trade. As you can see, how you place stop losses is linked to your account size, which also depends on the leverage level.
