Editorial Note: While we adhere to strict
Editorial Integrity,
this post may contain references to products from our partners. Here's an explanation for
How We Make Money.
None of the data and information on this webpage constitutes investment advice according to our
Disclaimer.
Stop loss orders are an important tool for traders to limit potential losses on a position. However, using stop losses incorrectly can also lead to missed profits or being stopped out too early. In this article, we will explore what a stop loss order is, the pros and cons of using them, and most importantly - how to use stop losses effectively to earn higher returns.
Learning how to use stop losses well takes practice like any other trading skill. Sticking to stop loss rules removes emotion from the equation and leads to improved trading performance over time. By implementing the strategies in this article, you can feel confident in setting stop losses that balance managing risk and maximizing profitable trades. The result will be a trading plan that earns greater returns while protecting your capital from large drawdowns.
What Is a Stop Loss Order? Definition
A stop loss order allows an investor to limit potential losses on a trade. It is placed with a broker as an instruction to buy or sell an asset when its price hits a predefined level. For long positions, the stop loss triggers a sell order if the price falls to the stop level. For short positions, the stop loss triggers a buy order if the price rises to the stop level. Either way, the stop loss converts to a market order once triggered to close out the position.
Stop losses provide investors a form of downside protection and risk management. Long investors can raise their stop level to lock in gains as the price climbs up. Short sellers can lower their stop level to secure profits if the price drops down. By using stop losses, traders can define the maximum loss they are willing to accept on a trade. This helps mitigate overall portfolio risks.
However, there are some risks to consider. Stop prices do not guarantee execution at that exact level. Price gaps and volatility can lead to execution at unfavorable levels sometimes. Overall, stop losses are a useful tool for managing risks within a disciplined trading plan.
Why Do Stop Loss Orders Matter?
As mentioned, the primary purpose of placing a stop loss order is to minimize the risk of potential losses. Moreover, it also makes your trading easier as it automatically gets executed if the defined price point condition is met. This strategic tool is especially useful for beginners for a less risky trading experience.
If you don’t use stop loss order then your open position can go out of control and you’ll have to face catastrophic consequences. It allows you to grow your trading account and perform better in the long run. You can also use this tool for better risk management because it allows you to determine the amount of money that you can risk on your trade and what position size is appropriate to take. You can also be interested in information about which stop loss order is better.
Main Types of Orders
Market Order
If you want to sell or buy security as quickly as possible, then you can achieve it by using the market order. It’s important to note that the market order only ensures that it will be executed immediately, but the price of the security isn’t guaranteed. It’s usually executed at or near the ask or current price. However, it’s not necessarily true that the market order will always have the last traded price.
Limit Order
Placing the limit order means that it’ll sell or buy certain security when it reaches a specified price or better. There are two types of limit orders which are a sell limit order or buy limit order. A sell limit order will be executed if the price of the security reaches a specific level or goes even higher. On the other hand, the buy limit order is executed when the price of the security drops to a specific level or even lower.
For example, if you want to buy a stock XYZ for no more than 5 US dollars. Then your buy limit order will be executed automatically if the price of XYZ stock reaches 5 US dollars or lower.
Stop Loss vs Stop Limit
Stop-loss orders and stop-limit orders offer different outcomes and are used for different purposes. The main difference between the two is that a stop loss order allows you to ensure the execution of the order and a stop-limit order allows you to ensure the price at which the order will be executed.
Upon triggering, Stop Limit order becomes a limit order, which will only execute at the specified limit price or better. However, if the price gaps and skips past the limit price before the order can be executed, the order may not be filled, leaving the investor exposed to further increasing loss. Also, in a rapidly moving market, liquidity can dry up quickly, making it challenging to get the order fully filled at the limit price, so there might be scenarios where only part of the order is filled before the price moves away from the limit price.
Until you gain experience, it's smarter to keep things simple with regular stop losses rather than more advanced stop limit orders.
How to Place Stop Loss Order: Step by Step Guide
Now that you understand what is a stop loss order and how it works, it’s time to figure out how to place it. In the following example, we will discuss the stop loss order placement by using one of the renowned online brokers “XM”. It will allow you to understand the process of modifying your trading orders by using the stop loss option. The platform allows you to enter the value of stop loss while you’re placing the market order. However, it must also include the level of stop limit that you’ll understand in the following step-by-step guide.
1
Step 1
In order to modify one of your active orders in your XM account with the stop loss option, you’ll need to right-click on your active order and click on the “Modify or Delete” option as shown in the image below.
Stop Loss Order in MetaTrader
2
Step 2
Now the system will open another window to modify your order where you’ll be able to see the stop loss option as the image below illustrates.
Stop Loss Order in MetaTrader
3
Step 3
You can either enter the amount directly in the field or you can also select the level option to choose a certain number of points as shown in the image below.
Stop Loss Order in MetaTrader
Keep in mind that the modification that you’ll make to your order regarding stop loss must include the limit and stop levels values.
Stop Loss Order in MetaTrader
4
Step 4
For example, if your order is on EUR/USD currency pair, then the stop loss value must be at a distance of at least 40 (pips) points from the current bid price and/or the current ask price.
Stop Loss Order in MetaTrader
It means that the value for the stop-loss order is calculated according to the bid and/or ask prices and not the opening price.
Stop Loss Order in MetaTrader
5
Step 5
If you modify the level point to 100 and click on the “Copy as” button the value will be automatically copied and pasted to the “Stop Loss” field.
Stop Loss Order in MetaTrader
Stop Loss Order in MetaTrader
Moreover, if your modification also includes the stop level values as discussed above then the color of the big “Modify” button will change to blue from grey as shown below.
Stop Loss Order in MetaTrader
6
Step 6
As soon as you click on the “Modify” button, your stop loss modification will take effect instantly. You’ll be able to see the new value of stop loss in the corresponding column of your active order.
Stop Loss Order in MetaTrader
7
Step 7
If you’re dealing with a pending order then the stop loss option will automatically be enabled.
Stop Loss Order in MetaTrader
But you’ll need to manually input the correct price because you won’t be able to use the point value. Don’t forget to include the stop limit level values according to the activation price of your pending order that you set.
Stop Loss Order in MetaTrader
Stop Loss Order. Alternative Opinion
As mentioned, a stop-loss order can lock in the losses that can be avoided otherwise. That’s why many traders and investors don’t like stop orders and don’t advise using them. For example, if you buy gold futures and go long at 1280 US dollars and modify your order with a stop loss at 1270 US dollars. You want to minimize your losses to 1,000 US dollars where the decline of 1 US dollar in contract price equals 100 US dollars of loss.
But if the market is moving very fast, then it’s possible then your stop loss order will execute at 1265 instead of 1270 US dollars. Resultantly, it’ll generate a loss of 1500 rather than 1000 US dollars which will be 50 percent more than what you expected. In order to deal with such situations, expert traders advise using options where you can set the strike price. In the above example, you will set the 1270 US dollar strike price and you won’t lose more than that.
There is also a widespread belief among some traders that brokers and large traders engage in stop loss hunting and deliberately break traders’ stop losses.
Stop Loss Order Example
If you’re using the MT4 platform, then the stop loss order will show the stop level on your chart as a horizontal line (dashed) as shown in the image below.
Stop Loss Order
The above image shows the long trade example where the GBP/USD currency pair is under consideration. You can see the resistance line in black color that shows that you now can purchase the GBP/USD currency pair. It’s basically your prediction that the price of the currency pair will increase.
In this stop loss order example, the area below the last big bottom can be a great place where you can set the value of your stop loss order (shown in a dashed horizontal line). You can also see a red downward arrow that illustrates the difference between your stop-loss order price placement and your entry zone. In other words, this is the amount that you will risk on this particular trade. If the value of the GBP/USD currency pair reached the red dashed line, then your stop loss order will be automatically executed. On the other hand, if the value of the currency pair remains above your entry point, you’ll earn profit and vice versa. As the image shows, the stop loss order will ensure that your losses don’t increase if the price of the currency pair decreases from 1.40834 US dollars in the normal market conditions.
Best Trading Platforms
Regardless of the type of trading, you’re interested in, the selection of the right online brokerage probably plays the most important role to achieve success. But this process can be very daunting because of countless available options in the market. In order to make it easier for you, we have come up with a list of the best online brokers that you can choose. Not only do these brokers offer a great online trading environment but they also offer great features and tools that you can use to achieve your financial goals most efficiently and effectively. We recommend you read each following broker carefully to ensure that you choose the option according to your unique needs.
FxPro is one of the best online trading platforms that was founded back in 2006. It’s considered a low-risk and highly trusted online broker, especially for Forex traders. One of the best things about this online brokerage is that it offers multiple trading platforms and MT4 can be your best option. Not only because it’s highly customizable and easy to understand, but also because of the fact that it offers all types of orders that you need. If you’re looking for an excellent online brokerage to perform stop-loss trading then you can choose FxPro.
FxPro MT4 Profile
Order types available: Market, Limit, Stop, Trailing Stop
Products offered: Forex, CFD
Number of base currencies: 8
Regulations: FCA, CySEC, SCB, and FSCA
MT4 Pricing: No commission, floating spreads
MT4 execution: Market
Demo Account: Supported
Other features: Great customizability, clear and detailed fee report, order confirmation
If you’re looking for an online brokerage for stock, ETFs, and options trading then Webull can serve you greatly. It’s also one of the top-rated online trading platforms regulated by renowned financial bodies. It offers great educational material and research tools that you can use to make the most educated and informed trading decisions. The best thing about this brokerage is its long list of available order types that you can use to improve your overall trading experience.
TD Ameritrade is yet another great online brokerage that was founded way back in 1975. It offers great features and tools that both beginners and professionals can use for efficient trading. The best platform that TD Ameritrade offers to perform trading with stop loss is Thinkorswim. Other than some standard order types, this platform offers some advanced ones as well. It’s also a highly trusted brokerage that’s regulated by multiple financial bodies.
Thinkorswim Profile
Order types available: Stop-market, Trailing stop percentage, Stop-limit, Limit
Pricing: No minimum deposit, overall low-cost broker
Demo Account: Supported
Other features: Personalized notifications, easy-to-use, excellent customizability, great learning material
Summary
A stop-loss order is a great tool that can limit your losses effectively. But it’s important to use it appropriately and many investors and traders failed to do so. You can consider it the insurance policy that provides you with the necessary peace of mind that your investments have an extra layer of protection. Make sure that you choose the online brokerage that not only offers everything that you need for trading but also comes with multiple order types. We hope that this guide will help you to understand what it actually is and how to use it in the most effective way.
FAQ
What is the 1 percent trading rule?
The 1% trading rule is a prudent risk management strategy embraced by traders to cap the potential loss on any single trade to 1% of the total account value. The rule doesn’t pigeonhole traders into using only 1% of their account for each trade. They can leverage more capital if necessary, but the stop loss mechanisms must be in place to ensure that losses do not surpass the 1% mark of the account value. By adhering to this rule, traders can significantly minimize their potential losses, which is crucial for long-term trading success. It's a vital concept especially for day traders aiming to manage risk effectively and increase their chances of success over the long haul
How to set up long-term stop loss?
A great approach to set up a long-term stop loss is to use resistance levels and technical support levels. So, if you want to go long on any stock, you can define the value of your stop-loss order slightly below the next technical support level. On the other hand, if you want to go short then you can set the value of your stop-loss order slightly above the upcoming resistance level.
Does stop-loss always work?
The simple and one-word answer is, no. However, in normal market conditions, it keeps you from falling victim to big losses. But keep in mind that stop-loss orders aren’t bulletproof. You can also use alternatives to stop-loss order if you want such as options if you want.
What is the difference between stop-loss orders and stop-limit orders?
The stop-loss order ensures the order execution and the stop limit ensures the price of the order when it’ll be executed. Both of these order types serve different purposes and you can choose the one that yields better results depending upon the applied conditions on a specific trade.
Upendra Goswami is a full-time digital content creator, marketer, and active investor. As a creator, he loves writing about online trading, blockchain, cryptocurrency, and stock trading.
Professionally, he has been a marketing professional running his agency for three years now. His agency helps finance projects to grow with the help of internet technologies. Upendra Goswami is an active investor and enthusiast of stocks and cryptocurrency.
Knows about
trading, blockchain, cryptocurrency, stock trading
Alumnus of
JECRC UDML College of Engineering, Jaipur
Dr. BJ Johnson is a PhD in English Language and an editor with over 15 years of experience. He earned his degree in English Language in the U.S and the UK. In 2020, Dr. Johnson joined the Traders Union team. Since then, he has created over 100 exclusive articles and edited over 300 articles of other authors.
The topics he covers include trading signals, cryptocurrencies, Forex brokers, stock brokers, expert advisors, binary options. He has also worked on the ratings of brokers and many other materials.
Dr. BJ Johnson’s motto: It always seems impossible until it’s done. You can do it.
Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO). Mirjan is a cryptocurrency and stock trader. This deep understanding of the finance sector allows her to create informative and engaging content that helps readers easily navigate the complexities of the crypto world.
