In a highly volatile stock market, a stop-loss order is a way to exit yourself from trading. It is a method to minimize or cap your losses by placing a buying or selling limit on the price on which you intend to trade in the stock market. It can be considered as an offsetting order which closes or exit your trade if the certain price level is reached.
For example, If you buy EURUSD Forex pair at 1.1015 expecting it to rise further. Assuming this, you place a stop loss order at 1.005, expecting that this level is the lowest before it goes higher again.
This way, under this situation, your possible loss will limit the risk at .0010 per a lot of trade. There are two ways through which traders use stop loss order, in general.
- A stop-loss is used to exit all trades. Here the stop loss order is placed on each trade at price level on which the trader wishes to exit. This is the regular type of stop-loss order.
- In the worst case stop order, the trader manually exits from the trading in case the market conditions do not match is a prediction. However, he may also set a worst case stop order to limit his risk or loss in the case where the manual exit is not possible or does not occur.
Placing a stop loss order is a wise and sensible method of risk mitigation. Because sometimes it is out of a human tendency to be impulsive which forces him to hang on to the losing trades. This order is automatically executed and safeguards his capital loss.
The most common type of stop-loss order is a “Stop-loss market order”. In this type of order when the price of an asset reaches the stop-loss price, this order is automatically sent by your broker to close your trading at the current position.
In fast-moving market conditions, the price level at which the trade is exited may be one of the disadvantages of trading with stop loss orders. Some traders prefer manual exit of trade because they think that they can manually exit whenever the conditions are favorable as opposed to the stop-loss order where the trading automatically exit in unknown conditions.
Another type of stop-loss order is “Stop loss limit order”. In this type of order, when the price of an asset reaches your stop loss price, the limit order is automatically sent by your broker to close the position at stop loss price. But in this case, the stop-loss limit order well closes the trade at stop loss price or better. Whereas the stop-loss market order will close the trade at any (Current price) price. This method eliminates the slippage problem.
The best way is to use a stop-loss market order and exit the trade manually wherever the conditions are favorable. Most traders use a stop loss market order as their regular stop loss is highly beneficial. It ensures your automatic exit, so you are not tempted to gamble or become impulsive.
So keep your plans ready for day closing as a part of your long term strategy.