Stop Loss Order

A stop loss order is an order placed by the trader, to be triggered automatically at a specific price or time.

The purpose is averting any further equity losses, should the value of the financial instrument move in an unwanted direction.

Traders typically use stop losses as part of a trading strategy, where they have clearly defined profit targets and exit methods.

Thus, there are no fixed rules on how or where or when to apply a stop loss order; it is up to the trader to find what stop loss suits their style of trading.

For example, day traders might use tight stop losses, while swing traders may be more flexible with their stop loss.

Why Use Stop Loss Orders?

There are several benefits of using a stop loss orders. First, the trader doesn’t need to constantly monitor the price of their instrument, since they know if things turn bad, their stop loss would deal with the situation.

Moreover, during quick moving price action, since a predefined stop loss gets triggered automatically, and usually with delay, stop loss orders eliminate the trader from having to manually execute a market order.

These may or may not get filled in time, or at the right price.

Often position traders don’t even use a predefined stop loss, nor do scalpers, but for different reasons.

This is because position traders’ trade size is usually a much smaller percentage of their equity compared to other types of traders.

By extension, scalpers want to quickly enter and exit the market, and sometimes it’s just quicker to manually exit via a market order as soon as the need arises, without taking the time to set a fixed profit target or stop loss.

There are a number of ways in which a stop loss can be employed. The main types are based upon a) the percentage of one’s equity, b) a fixed time to exit, or c) technical analysis.

An example of a stop loss is the following. A trader wants to buy GBP/USD in the morning during the London session, because they think it will rise in price over the next few hours.

The current exchange rate is 1.5540, so the trader buys at this price, aiming to exit for a profit at 1.5590.

However, just in case the bears take control, the trader sets a stop loss order at 1.5510. This is a stop loss of 30 pips.

If price then drops during the day, the stop loss order will be instantly executed at 1.5510, and the trader would have taken a loss of 30 pips.

There’s of course always a tradeoff, between setting a stop loss too tight to avoid large losses, but is prone to being triggered too frequently, and between setting a stop that’s too wide to allow price action to take its course.

However, this carries the risk of taking a larger loss, should price not follow the traders’ expectations.