Some people are skeptical about using a Stop-Loss. After all, what goes up must come down, right? Can't I just leave a losing trade alone and eventually it will bounce back?
This type of logic is very common in all sorts of markets. It seems plausible but it's ultimately flawed and it's a poor idea to trade without a Stop-Loss.
It's true that using a Stop-Loss is admitting defeat. You throw in the towel. Call it quits. Basically, you are making a conscious, manual decision to take a loss.
Why on Earth would anyone do that?
There are several good reasons!
First off, let's look at the popular belief, "If I let my trade go long enough, it will eventually bounce back into profit".
This is a very common belief. So common, in fact, that they have given it a name.
It is called, "The Gambler's Fallacy".
Gambler's use this type of logic all the time! Walk up to any roulette table in a casino. You are bound to here a variation of the following:
"It's hit all around my number! I've lost X amount of times in a row! It's due to hit. At this point, it's gotta hit soon!"
The problem is that IT DOES NOT HAVE TO DO ANYTHING! The roulette wheel has no memory. It is purely a game of chance.
If the number 36 hits 10 times in a row, what are the chances that the next number will be 36?
The same. Generally 1/37 or 1/38 (depending on if it's a single zero game (European Style) or a double zero game (American Style)).
Past events do not influence future ones in games of chance.
The odds never change - period.
But isn't Forex a bit different because Forex is not a game of chance?!
Yes and No.
Forex is technically NOT a game of chance. Forex is influenced by specific factors, such as world news events and the economy.
However, the real price mover is other investing individuals. Their confidence levels determine their course of action. The ratio of the buyers to the sellers is really what moves the markets up or down.
The problem is that it is impossible to predict with 100% accuracy how people will react to certain news events or to a specific economy. Different interpretations will always ensue over the same exact stories and events.
Why?
Because all people are not hard-wired the same way. Some see the glass as half-full and others see it as half-empty. Essentially, it's the ratio of optimists to pessimists that concerns us.
The problem is that you cannot predict how people will react. You can make predictions but you will not always be 100% correct. Furthermore, it's impossible to even know how many people or which people are currently playing in Forex.
Forex is not a game of pure chance because ever-changing factors influence it continuously. You have a much better chance being well-prepared in Forex than you'd ever get in a casino (because skill does not exist on slot machines or roulette wheels).
The problem is that we can never know WHEN or HOW MUCH a currency price will "turn around". Sure, everything seems "destined" to turn around eventually. In a way, it's true. But it could be next month, next year, or not at all. There are not guarantees in Forex.
Thus, if you have a losing trade, you should simply cut it off at your pre-determined point. Letting it run is simply gambling with your money. It might stay in the negative for days, weeks, or months.
Worst case scenario is that it never turns around in time, and you blow your account with ONE poor trade. Ouch.
Not-so-worse scenario is that the trade lingers for weeks or months in the negative. It never goes positive, but it also doesn't blow your account. This is actually not good at all. You are paralyzed during this entire time period. You can't open another trade because you will reduce your margin considerably and probably cause the trade to be closed out. Not being able to trade means you cannot place any winning trades! This means you are losing money without even knowing it as you watch all the profitable trades pass you by!
Second-best scenario is that you set up an appropriate stop-loss (say 2% of your account) and the negative trade triggers it. Your trade is closed out, and you've lost only 2% of your account. You are free to start trading again the next day, and you go on to win several trades in a row. Not only do you recoup your losses, but you actually come out ahead! You are now free to trade more and make even more profit.
Best-case scenario is that the trade magically turns around and banks you some profit. You lose nothing and come out ahead. This happens occasionally, but it's much more risky and rare. The price might turn around just after your account has all ready been blown up (bummer!). Or it might do it immediately. It's impossible to say. I can certainly tell you with 100% confidence that trading without a stop-loss and praying for a negative trade to turn around is not ideal and is about as close to gambling with your money as you can get. Avoid it. Just take the small loss and move on!
Hopefully this clears up the stop-loss confusion. Do NOT fall for the Gambler's Fallacy!
Remember to always trade with a S/L!
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