Just What is a Limit Order in Forex Trading?
There are two varieties of conditional orders that one can use with foreign currency trades: the stop loss (in some cases written stop/loss) and the limit order. These are named conditional orders for the reason that they'll not come into effect except if particular conditions are attained.
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The stop loss is a really well known instruction that controls the risk associated with the trade. With a stop loss, you're saying to the broker "In case the price goes this far against me, I want out." So should you have purchased the foreign currency pair hoping for a rise in price, but then the price drops, you'll not see your total account balance wiped out. The stop loss will kick in and protect the majority of your capital.
Limit orders are similar but relate to the opposite scenario, the situation where there is a winning trade. By using a limit order, you are saying to the broker, "When the price gets to this particular level, that is enough, I will close there and take the profits." The limit orders are going to be activated if your pre-arranged price is achieved and the trade is going to be closed at that price.
A lot of traders are unwilling to use limit orders as it appears counter intuitive. When the market is going your way, why would you need to close the trade? Wouldn't you want to hang on as long as possible to get the most profit from it? The issue with that strategy is sooner or later the price will reverse and frequently it does it sooner rather than later. If you do not place a limit order, when will you close the trade? Just how will you realize when it's gone as far as it is going? When you wait too long, a sudden reversal could possibly see your gains eliminated. So unless you have a method which is defined with really precise criteria to tell you when to close a trade, you will likely be better off if you use limit orders.
And where does one set them? Back testing your system can be helpful here. You can check through the past months and years of forex markets that would trigger a trade under your system and figure out what exactly would have been the perfect setting for the limit order. Don't forget of course that previous results are not always going to be repeated in the future. Testing in a simulated demo account can also be helpful.
Usually you will want the limit order to be further from your starting point than your stop loss, even after spread is considered. This will likely mean that you only have to score a 50% success rate to be in profit. Establishing the limit order at twice the pips of the stop loss, either before or after spread, might be suitable. On the other hand, this is dependent upon your system. Never bypass the testing.
Working with limit orders has another valuable advantage as well. Once you have both stop loss and limit orders set up, you are able to leave the computer and get on with your day. You don't have to watch every single little fluctuation of price until either is activated. This lowers tension and makes it more unlikely that you will not panic and deviate from the original strategy. Therefore, applying orders that limit in currency trading trades can produce a happier, more profitable trader.
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