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Calculating a Stop Loss

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Leaving the discussion of whether stop losses should be used or not to one side for the moment (because there is no discussion, as a stop loss should always be used), the next discussion about stop losses is how to place a stop loss correctly, so I am going to explain exactly how a stop loss should be calculated so as to be placed correctly.

Calculating a Stop Loss (Get Your Calculator Ready)

The correct way to calculate a stop loss is ... not to calculate a stop loss at all, because correctly placed stop losses cannot be calculated.

Many so called traders would disagree with this, and would say that a stop loss can be calculated, and would provide a variety of calculations to do so, but they would be wrong. A correctly placed stop loss cannot be calculated because financial markets do not move according to any such calculation, and therefore a stop loss that is calculated will not be based upon the movement of the market, and will therefore be placed incorrectly.

Correctly Placing a Stop Loss (Put Your Calculator Away)

The correct way to place a stop loss is at a price that should not be reached if the trade in question is going to be profitable. In other words, a correctly placed stop loss will only be reached if the market movement is such that the trade in question should no longer be kept active. For example, if a long trade on the Euro to USD currency market is made at 1.4506, and if the trade is going to be profitable, the market should not trade below 1.4488, then a correctly placed stop loss would be below 1.4488, because the trade would then be exited at the price at which the trade was no longer a good trade to keep active.

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