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What is a Stop Loss order?

What is a Stop Loss order?
Asked by
Brian Hayslip categorie-icon time-icon6 months ago

Justin Freeman
Answered time-icon6 months ago

A Stop Loss order is an automated instruction to liquidate a position at a specific price. They are placed in advance of a price moving towards that particular level with the intention of limiting losses on trades that turn bad.

Stop losses are determined by individual traders who then input that information into the Broker Platform they are using. The Broker will then enter an instruction into the market to automatically execute the referenced price level. In certain market conditions it can be hard to actually execute trades and Stop Losses may be subject to Gapping Risk. As a result you may want to consider the cost/benefit of using Guaranteed Stop Losses or at least ensure you are familiar with the Terms and Conditions of your broker.

Taking the below price chart in Gold CFD. Using a 15min time interval and Opening Range Breakout strategy the trader sells short at 1200.08. The Stop Loss is set at 1202.00, which is just above the high of the day, 1201.70. If the price turns bullish and reaches 1202.00 then the trade will automatically close out. A Stop Loss on a long position would be below the entry price level.

Each trading strategy (such as Fading or Scalping) has its own approach to where Stop Losses should be set. Stop Losses should be determined during the research stage, not the trading stage of your trade’s life.

Pros

  • The automated nature is a big advantage, especially with markets that trade overnight.
  • It also creates a more disciplined approach to applying you trading strategies as it would take manual intervention to override/cancel a Stop Loss that is put on at the time of a trade.
  • Stop Losses should not be adjusted away from price action to try to keep a trade alive. That can lead to significant losses and instead take the hit and spend time evaluating your trading strategies.
  • Moving stop losses to follow a profitable trade is a commonly used trading tool. Trailing Stop Losses can ensure that a once profitable trade makes a small profit or at least breaks even should the market turn. Trading Momentum based trading strategies might involve selling part of a profitable position but leaving the rest to run. The realized profits then set off against the Stop Loss that remains at the original level.

 

Cons

While it is strongly recommended that you do use Stop Losses there are some situations where you might consider taking them off, maybe even momentarily:

  • News events such as the release of economic data, although running to fixed schedules, can still create momentary periods of abnormally high price volatility. A whip-sawing action is possible until the market digests the new, and these spikes in prices can hit stop losses and close positions out at a loss. As a result some traders take stop losses off around significant releases such as Non-Farm Payroll announcements and re-enter them once the price action becomes less volatile.
  • Consideration will also be given to longer term changes to market conditions. For example, if price volatility is high and reaches 4% then Stop Losses set based on price volatility levels of 2% would be more likely to be triggered.

 

It is possible to trade the markets without using Stop Losses. In fact, the functionality of Broker Platforms is such that you have to actively instruct to have a Stop Loss applied to your positions. The default is to have no Stop Loss applied. Be aware that you are responsible for inputting Stop Losses.

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