CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 77% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 77% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

What Is a Stop-Loss Order?

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In this article, we take a look at what is a stop-loss order, how stop-loss orders work, and why it’s a good idea to implement them in your trading strategy.

What Is a Stop-Loss Order?

A Stop-Loss Order is a type of closing order, allowing the trader to specify a specific level in the market where if prices were to hit, the trade would be closed out by our systems automatically, typically for a loss. This is where the name stop-loss originates from, because the order effectively stops your losses.

A stop-loss is one of the most popular tools for traders to minimise their risk. If you are only willing to accept a certain level of loss, a stop-loss will close the trade once prices hit the price level you’ve defined.

A stop-loss is automatic, meaning you don’t have to manually monitor your positions. This provides a certain level of control and comfort. Experienced traders will testify that one of the keys to achieving success on financial markets over the long term is prudent risk management.

How Does a Stop-Loss Order Work in Practice?

Stop-loss is a crucial part of experienced traders’ risk management strategy. By placing a stop-loss order, the trader can automatically exit a position if the price for their security starts moving in the direction opposite to the position they’ve taken.

In practice, a stop-loss order to sell instructs the broker to sell a security if the market price for it drops to or below a specified stop price. A stop-loss order to buy sets the stop price above the current market price.

This is especially useful for short-term traders and day traders who don’t have time to manually monitor the price movement during market open hours. It ensures that their position is closed when the price reaches a certain level specified beforehand by them even when they need to step away from the screen.

Example of a Stop Loss Order

Source: xStation
Please be aware that the presented data refers to the past performance data and as such is not a reliable indicator of future performance.
 

Let’s take a look at the example above. The trader has opened a long position on EURUSD in expectation that it will increase in value above 1.09935, which is shown by the first line.

You’ll notice a second line below that, which is a stop-loss set at 1.09842. This means that if the market falls below this level, the trader’s position will be automatically closed at a loss - meaning that the trader is protected from any additional price moves lower.

Pros and Cons of Stop-Loss Orders

Essentially, a stop-loss order helps to manage your risk and keep your losses to an acceptable and controlled minimum amount. Stop-loss orders are a smart and easy-to-use way to manage the risk of unexpected losses on a trade.

The benefits of using stop-loss include:

  • Helping traders lock in profit.
  • Adding discipline to traders’ short-term trading efforts.
  • Eliminating the need to monitor trades on a daily or hourly basis.
  • Helping traders take emotions out of trading by forcing them to make the most important decisions before potentially unpredictable scenarios take place.
  • They are suitable for virtually every trader who wishes to make them a part of their investment strategy, regardless of their level of experience.

However, it’s important to keep in mind that using stop-loss orders comes with its own set of disadvantages. These often include:

  • Price gaps - if a stock price suddenly gaps below or above the stop price, the order would be triggered. The stock would be sold or bought at the next available price even if the stock is trading sharply away from your stop-loss level.
  • Getting stopped out in a choppy market - if a market quickly reverses itself and resumes in the direction that was beneficial to your position, it might be in your best interest to keep your position.

Do Stop-Loss Orders Provide Complete Protection?

While stop-loss orders are one of the best ways to ensure your risk is managed and potential losses are kept to acceptable levels, they don’t provide 100% security.

Stop-losses are free to use and they protect your account against adverse market moves, but please be aware that they cannot guarantee your position every time. If the market becomes suddenly volatile and gaps beyond your stop level (jumps from one price to the next without trading at the levels in between), it’s possible your position could be closed at a worse level than requested. This is known as price slippage.

Ask our account managers for more detail or find out more about risk management in this article.

FAQ

A stop-loss order is an order placed with the broker to buy or sell a specific stock once the stock reaches a certain price. A stop-loss is designed to limit an investor's loss on a security position. For example, setting a stop-loss order for 10% below the price at which you bought the stock will limit your loss to 10%.

The key difference between a limit order and a stop-loss order is that the limit order will only be filled at the specified limit price or better. On the other hand, once a stop order triggers at the specified price, it will be filled at the prevailing price in the market, which means that it could be executed at a price significantly different than the stop price.

Placing a stop-loss order is ordinarily offered as an option through a trading platform, such as XTB’s xStation, whenever a trade is placed, and it can be modified at any time. A stop-loss order effectively activates a market order once a price threshold is triggered. Traders customarily place stop-loss orders when they initiate trades.

The main benefit of using a stop-loss order is helping you to manage your risk and keep your losses to an acceptable and controlled minimum amount.

They are especially useful for short-term traders and day traders who don’t have time to manually monitor the price movement during market open hours. A stop loss ensures that their position is closed when the price reaches a certain level specified beforehand by them even if they need to step away from the screen.

A stop-loss can fail as a loss limitation tool because hitting the stop price triggers a sale but does not guarantee the price at which the sale occurs. Once the stop price is breached, the order becomes a market order and the stock can sell at an even lower price.

A stop-loss order limits your exposure to less of a loss than you might otherwise experience by automatically closing out your position if your stock trades to an unfavourable market price level that you designate.

It’s not necessary for long-term investors to be overly concerned with market fluctuations, as they're in the market for the long haul and can wait for it to recover from temporary downturns.

This content has been created by XTB S.A. This service is provided by XTB S.A., with its registered office in Warsaw, at Prosta 67, 00-838 Warsaw, Poland, entered in the register of entrepreneurs of the National Court Register (Krajowy Rejestr Sądowy) conducted by District Court for the Capital City of Warsaw, XII Commercial Division of the National Court Register under KRS number 0000217580, REGON number 015803782 and Tax Identification Number (NIP) 527-24-43-955, with the fully paid up share capital in the amount of PLN 5.869.181,75. XTB S.A. conducts brokerage activities on the basis of the license granted by Polish Securities and Exchange Commission on 8th November 2005 No. DDM-M-4021-57-1/2005 and is supervised by Polish Supervision Authority.

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