Introduction to Stop-Loss Orders

Introduction To Stop-Loss Orders

Are you familiar with using stop orders to manage your trading positions? These days, it’s very common for traders to enter a stop order to limit their risk on open positions, but a lesser known use for stop orders is to enter trades as well. By definition, a stop order is an order with your broker to take a long position at or above a specified price, or to short it at or below a specified price. For example, if you’ve taken a long position in the EUR/USD at 1.3000 and you wish to exit your position if the price falls to or below 1.2975, then you would place a stop order with a stop price of 1.2975. Your order will be entered into the system as a standing order, and once the price falls to 1.2975 or below, your stop order will close out your long position at the best possible price available at that instant.

Stop orders are very useful because they save you from having to sit at your computer and manage your positions manually. With a stop-loss order in place to protect your open positions, you don’t have to be afraid that your trades may go far and away against your pre-planned exit point before you can place the order to get out. It also forces you to accept the loss immediately instead of letting it go further and further beyond you. In the case of a drastic adverse movement, often caused by sudden news releases or catastrophic events, a stop order can literally save you hundreds of pips!

Using Stop-Loss Orders To Exit Trades

When you use stop-loss orders to manage your open positions, you gain the added advantage of reducing your margin requirement to maintain that open position. That means that you free up your capital to take other trades, or simply have more of a buffer against any adverse movement. This reduced margin is a reflection of the drastically reduced risk on your position as recognized by your broker. Because the Forex markets are so liquid, a stop order is more or less guaranteed to be executed at the price that you set it for, give or take a pip or two in the worst market conditions.

The biggest advantage of using stop-loss orders to exit your trades is to enforce discipline and ensure that you get out of your trades when you are supposed to. If you consider most of the losing traders in the Forex arena, the biggest losers are the ones who don’t take their losses. Instead, they allow them to develop from a twenty or thirty pip loser to a magnitude of hundreds of pips, and by then they are facing margin calls and all kinds of emotional distress, simply because they can’t take their losses. With stop orders, you can pre-plan your “get out” point and save yourself from being another cautionary tale in the Forex community.

Using Stop-Loss Orders To Enter Trades

Obviously, stop orders are an essential tool for managing open positions, but what about entering positions? Many traders would find it hard to understand why anyone would use stop orders to enter trades, after all why would you want to get in at a worse price than is available on the market?

Stop orders are useful for trading strategies where you are “buying strength” and “selling weakness”. If you’ve been trading for some time now, you will notice that there are occasions where support will hold and prices will rebound from a strong support. When the support does give way though, you will often see the price shoot through support with strength. One way to take advantage of the collapse of a support point or a breakout of a resistance point is to use a stop order to enter your position.

For example, if you know that there’s a significant resistance point in the EUR/USD at 1.3000 and the price is currently at 1.2990, you wouldn’t want to take your long position until you know that the resistance is broken. Otherwise there’s a very small upside and a huge downside. So, you can simply use a stop order at say 1.3020 to enter your position. Chances are, if the price goes far enough beyond the resistance, it will be taken by the market participants as a breakout, and traders will pile on the move, resulting in a significant move to the upside.

All in all, stop orders are a very handy tool in any serious trader’s arsenal. Why not try out stop orders in your trading and see how you can improve your trading results with them?