Stop-loss will help protect your account from risks that will expose you to major losses. We’re going to explain 4 ways you can use stop-loss orders to pretect your account. Putting a stop-loss order on a trade is easy enough, but how does a trader know when and where to put one?
What is stop-loss?
Stop-loss in trading is an order you request from your broker to reduce the chance of a loss on a trade. This offers you, as the trader, higher financial returns during trading by selling a Security after a certain price is reached for that security.
What types of stop-losses are there?
There are four types of stop-losses, namely the percentage stop, the volatility stop, the chart stop, and the time stop. All of these can be ordered within certain windows to prevent losses, or encourage certain outcomes in your favour.
1. The percentage stop
This strategy works by only risking a maximum of 2%. Traders are able to mostly protect the capital put into trading. In the event of a loss, the amount will not be as detrimental to the trade as a higher percentage would. There is a drawback to this strategy though. The market conditions are not taken into account. This does not give your trade enough room within the market to gain movement in your favour.
2. The volatility stop
The volatility stop-loss strategy is a great method of a stop-loss order. It’s based on past price movements of a particular currency pair. Which, means that you can monitor what happened in the past and make decisions about current trades based on those trends.
3. The chart stop
The chart stop makes use of support and resistance levels. By rendering your trade invalidated once the price breaks above either a support, or a resistance level. Making sure to exit a trade as soon as possible after it has been invalidated means less risk to you as the trader.
4. The time stop
Placing a time-based stop-loss order is a great strategy to take when a trade isn’t going in any particular direction. It’s also used when you want to exit the market around certain times, like on a Friday evening. Leaving the market during the night takes away the risk that a trade may turn against you. It’s a suitable strategy for traders who prefer to make short-term trades and who exit their positions overnight or over weekends.
Some important things to keep in mind when putting in stop-loss orders
Firstly, avoid trading with very tight stop-loss orders as there is not much room allowed for volatility. Likewise, don’t order stop-loss on very wide positions as high volatility poses the risk of greater loss. Be flexible with the number of pips risked during the trade, but also be sure to place your stop-loss in such a way that your trade will be invalidated in a certain situation.
Finally, avoid placing a stop-loss order directly on a support or resistance line by only trading within a certain zone to ensure you stay away from the line where the price does not count in your favour.
While a stop-loss should not be regarded as a means to treat your trades as a gamble from which you can withdraw when the game isn’t playing out in your favour, it still is a valuable method used by traders that can be greatly beneficial once you get the hang of it.
Check out some of our other blog posts for more tips and tricks of the trade.