The stop loss order is the superhero of investors and traders. It protects us against evil. Stop loss orders limit our loss by automatically closing our trades if price turns against us. We salute you! In this blogpost I’ll explain how a stop loss works and how you can use it to your advantage.
What is the definition of a stop loss?
Literally a stop loss will stop you out at a loss. You place the order at the price level where you’re willing to take your loss on a trade.
If the price you set is reached, your trade will be closed automatically.
Example of a stop loss
Below you can see a trade that I made on Bitcoin. My entry was at the $6400 level breakout. But at the time I entered I obviously didn’t know if price would really move up.
There is always a chance that the price will move in the other direction. For example if bad news comes out for Bitcoin.
If that were to happen, price could dump pretty fast and I would lose a lot of money.
To prevent that, I place a stop loss just below the lowest level (support) that the price has recently reached. In this example just below $6250.
Suppose the price of Bitcoin had tanked, my trade would have been closed just below $6250 at my stop loss level. I would have taken a loss, but it would have been a limited loss.
The trailing stop loss: a cool variation on the stop loss
A stop loss order automatically closes your trade. Even if you are not at your computer or have your phone with you. A cool variation on the stop loss is the trailing stop .
A trailing stop follows price in the direction of your trade. So it moves up (with a long) or down (with a short) at a set distance.
As soon as price moves in the opposite direction, the trailing stop loss will stop moving and your trade will be closed at that price level where it stopped.
You set a trailing stop based on the distance in price or points that it has to follow the price.
In this case the trailing stop will follow the price at a distance of 55 points, or a -1.65 loss. Suppose price rises from our entry at $17 to $17.055, the stop will move from $16.945 to $17. Suppose that price suddenly drops, the trade will now be closed at $17.
A stop loss is like an insurance policy
A stop loss order is like an insurance policy for your trade. Suppose things go wrong, you limit the risk by taking a calculated loss.
If you have a good broker then you also have the option to practice on a demo account with different order types to see what they do.
78,3% of retail CFD accounts lose money
Any questions about the stop loss order? Feel free to drop them in the comments below!