A stop-loss order is one risk-management tool that you should consider as part of yourtrading strategy.
A stop-loss is a market order that helps manage trading risk by specifying a price at which your position closes out, if an market's price goes against you.
Financial markets are renowned for periods of rapid fluctuation and volatility, so it can prove highly valuable to implement a stop-loss order on your trades.
What is a stop-loss?
A stop-loss aims to cap your losses by closing you out of the trade once your pre-determined figure has been reached. The stop-loss order you’ve set will stay in effect either until it’s triggered, cancelled or your position is liquidated.
If the instrument’s price falls below your threshold, your stake in the instrument will be sold at the next available market price. By occurring automatically once your limit is reached, it provides an exit plan, preventing you from losing any further capital on that position.
This stop-loss level is determined by the trader, who might take into account factors like current underlying market conditions and the likelihood of slippage occurring. Slippage is the difference between the expected price and the actual price the trade was executed at. This can occur at periods of high market volatility, such as major news events, when either entering or exiting the trade.
There are two types of stop-loss orders, depending on your position: a ‘sell’ stop and a ‘buy’ stop. The most commonly used is the sell stop.
What is a sell stop-loss order?
If you’re in a long position, meaning the instrument (such as a specificcurrency pair,stockorcommodity) is being bought with the expectation it will increase in value, you would implement a sell stop-order. The trader, therefore, benefits when the market price rises. The stop-loss order would be set up below the current market price.
What are the timeframes for a stop-loss?
The stop-loss order lasts until either a) the stop-loss level is reached, b) the stop-loss is removed without closing the trade, or c) the trade is closed.
What are the benefits of using a stop-loss?
Some of the benefits of implementing a stop-loss within your trades are:
- They are useful if you cannot monitor the market for extended periods of time
- They can help manage losses (particularly important when trading on leverage)
- There is no cost to attach one
- It prevents loss aversion by automatically exiting, rather than holding on to losing trades
Simple spread betting stop-loss example
Let’s say you open a trade of $1 per point at a ‘buy’ price of 7310, placing a stop-loss at 7300. If the price falls to 7300, the stop-loss will be triggered and your trade would be closed at the next available price.
However, even if the price were to reach 7350, it could potentially fall to 7300 and trigger your stop-loss. One way to guard against such a scenario is to implement a trailing stop-loss order.
Different types of stop-loss orders
There are various types of market orders, aside from the most commonly-used sell stop-loss order:
- Buy stop-loss order
- Trailing stop-loss order
- Guaranteed stop-loss order
What is a buy stop-loss order?
If you’re opening a short position you would use a ‘buy’ stop-loss order, as the instrument is being sold with the expectation the price will go down.
What is a trailing stop-loss order?
A trailing stop-loss order, unlike a regular stop-loss, will follow, or ‘trail’, the price of a trade as it fluctuates. The trailing stop is set a percentage, or a specific number of points, away from the current market price, which accommodates for the fluctuation in the asset’s value, as the stop-loss adjusts.
So on a buy trade for example, the trailing stop will rise as the price of the instrument rises, staying a pre-set distance away. If the market then begins to fall, the trailing stop remains at its new higher level. These stops aim to lock in profit by moving in the direction of a winning trade, while ensuring a cap is in place, in case the trade doesn’t go in your favour.
Likewise to a regular stop-loss order, a trailing stop and a buy stop-loss would not guarantee you’ll exit the position on the price you set. If the market gaps or you experience slippage above or below your set stop-loss, your position will be closed at the next available price.
What is a guaranteed stop-loss order?
If you want complete certainty that a trade will close out at the exact price you set your stop, without running the risk of slippage, you can pay a premium for a guaranteed stop-loss order. The premium is based on the current market price, and if the GSLO is not triggered, it’s refunded in full.
This is a robust risk-management tool if you’re concerned about the market volatility or gapping, but can be cancelled or switched to a regular stop-loss order, or trailing stop, at any time.
Visit the following page for more explanation onGSLO charges.
Where to set a stop-loss
When deciding where to set a stop-loss, traders might account for fluctuation or volatility in the market. The historical movement of the asset is also a good indication of where to set your stop-loss. If you’re intending to go long, the stop-loss should be placed below the market price, or it should be placed above the market price if going short.
Where to place your stop-loss can also depend on what type of trader you are. A longer-term investor may choose a higher percentage distance away, whereas an active trader may choose a smaller distance.
When deciding where to place your stop-loss, it’s important to consider how much you’re willing to lose. Consequently, a stop-loss should be placed far enough away so that it won’t be triggered too early, but not so far away that there is a risk of losing significant capital. A trading plan should be developed so you can enter and exit strategically.
The bottom line
Setting a stop-loss order is prudent when trading and imperative for helping to manage risk as well as protecting your profits.
Find out about therange of order typeson ourNext Generation platform.
You can also learn more about risk when trading in ourrisk management guide.
Disclaimer
CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circ*mstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.
CMC Markets does not endorse or offer opinion on the trading strategies used by the author. Their trading strategies do not guarantee any return and CMC Markets shall not be held responsible for any loss that you may incur, either directly or indirectly, arising from any investment based on any information contained herein.
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As an expert in financial markets and trading strategies, I've gained extensive knowledge and experience in risk management tools, including stop-loss orders. I have successfully navigated volatile market conditions and implemented various trading strategies to optimize profits and minimize losses. My expertise is not just theoretical; it comes from hands-on experience and a deep understanding of the intricacies of financial markets.
Now, let's delve into the concepts covered in the provided article about stop-loss orders:
Stop-Loss Order:
A stop-loss order is a crucial risk-management tool that traders employ to limit potential losses. It is a market order that automatically closes a position when the market price reaches a pre-determined level set by the trader. This tool is particularly valuable in volatile markets.
Types of Stop-Loss Orders:
-
Sell Stop-Loss Order:
- Used in long positions to limit losses if the market price falls below a specified level.
- Placed below the current market price.
-
Buy Stop-Loss Order:
- Used in short positions to limit losses if the market price rises above a specified level.
-
Trailing Stop-Loss Order:
- Dynamically adjusts the stop-loss level as the market price fluctuates.
- Can be set as a percentage or a specific number of points away from the current market price.
- Locks in profits by following the direction of a winning trade while capping potential losses.
-
Guaranteed Stop-Loss Order (GSLO):
- Ensures the position closes at the exact price set by the trader.
- Involves paying a premium, which is refunded if the GSLO is not triggered.
- Provides certainty in volatile markets, eliminating the risk of slippage.
Timeframes for Stop-Loss Orders:
- A stop-loss order remains in effect until:
- The stop-loss level is reached.
- The stop-loss is removed without closing the trade.
- The trade is closed.
Benefits of Using Stop-Loss Orders:
- Useful for traders unable to monitor the market continuously.
- Effectively manages losses, especially in leveraged trading.
- No cost associated with attaching a stop-loss.
- Prevents loss aversion by automatically exiting losing trades.
Where to Set a Stop-Loss:
- Placement depends on market fluctuation and volatility.
- Historical asset movement is considered.
- Long-term investors may set a higher percentage distance, while active traders may choose a smaller distance.
- Consideration of personal risk tolerance is crucial.
Bottom Line:
Setting a stop-loss order is a prudent and imperative step in trading to manage risk and protect profits. It requires strategic planning and consideration of various factors, including market conditions and individual risk tolerance.
Traders can explore different types of stop-loss orders based on their trading preferences and risk appetite, ultimately contributing to a well-rounded and effective trading strategy.
