A stop loss is an order that simply closes out your position at a specific, predetermined price. It is an excellent risk management tool, which limits your losses on any trade where it is used.
This can sometimes feel like the million-dollar question. We all know that horrible feeling when we place a trade, which then drops, hits the stop loss, only to almost immediately reverse and trade significantly higher. However, stop losses should definitely not be placed at random, there is plenty of theory for you to digest before deciding which stop loss strategy is best for you. The best price for a stop is at a level where the market has sufficient rom to fluctuate but not to get you out before the price trends higher (in a buy example).
What can I risk?
One way of determining the stop loss is to decide how much you are willing to risk on your trade. For example, if you wish to have a maximum loss of $20, you do the calculation to work out where the stop should go. For example, trading GBP/USD trade size 10,000, the price can move 20 ticks from say $1.4045 to $1.4025 and your position should be closed (with a precise fill) and your loss will be $20.
However, this method only takes into account what you are willing to lose and not what the price action in the market might be around that price level, so you could find this method is more counterproductive than useful.
Swing low method
One of the most widely used and simplest ways of deciding where to put a stop loss to put it just below a recent “swing low” (when going long) or a “swing high” when going short. These can be identified when looking at the chart. A swing low is where the price has fallen and then bounced off a certain price. This basically is where the price has found support. A swing high is the reverse.
As an alternative, technical analysis could be another way of finding stop loss levels. Fibonacci retracement levels are often used in this way.
The most important point here is that you should be clear as to how which strategy you will use for your stop loss placement. This needs to be in your trading plan and followed strictly.
Finally, when considering which broker to use, look for an ECN broker, such as Vantage FX. As an ECN broker they offer some of the tightest spreads in the industry and superior execution. This is important when your stops are being filled, as too many slips could make the difference between a winning and a losing account.