A stop-loss order is a formal instruction to purchase or sell at a particular price on a trading platform like a stock exchange, bond exchange, commodity exchange, financial commodity exchange, or currency exchange. These instructions can either be complex or very simple and are typically sent by a broker to a particular broker or directly from a trading platform to a trading exchange via direct access. This is usually the first line of defense when it comes to incurring large losses in the FX markets. A stop-loss order is designed to limit your loss if a trading strategy fails to generate positive returns for a predefined period of time. The advantage is that the risk level can be easily managed.
There is no doubt that some investments will provide excellent profits, while others will suffer. The nature of investment strategies means that a portion of the portfolio will occasionally fail to meet the predetermined returns. In those instances, the trader should exercise his or her stop-loss order and sell-side options. A stop-loss price is a predetermined maximum price at which you would want to liquidate all or part of your shares.
Many investors avoid stop-loss orders because they fear that they may inhibit their creativity. In reality, it is often an effective tool for controlling risk and giving investors peace of mind. Investors who use stop-loss orders are typically sophisticated and experienced traders. Many of them execute many trades daily. It is very common for stop-loss orders to be placed with large, long-term trading positions.
Because stop-loss prices are usually triggered on reaching a specific threshold, they are not a safety mechanism; they are designed to maximize profit. For example, when a trader knows that a particular stock has reached a specific per share target, he or she may place a stop-loss order so that all per-share sales are closed at this price. If the per-share sales still reach the target price, the trader will not enter into a new trade and will not incur any loss.
Stop-loss orders can be used with both long-term and short-term trading strategies. Most experts recommend placing stop-loss orders when a stock has reached a specific threshold, such as the maximum price reached during the first 30 days of a stock’s trading year. Stocks that are regularly traded in small quantities may not stay in a profitable position for extended periods. Longer time frames, including a daily or weekly chart, can help a trader identify trends. Using multiple charts at once, coupled with stop-loss orders if appropriate, will help a trader determine when to enter a trade.
Investors should use discretion when making use of a stop-loss order. A stop-loss order may only be placed at predetermined points on a chart. This is a good strategy if a trader anticipates a certain trend or pattern from security. If the key takeaways exist, such as a price that is constantly changing, the stop-loss order may be positioned at a point that may change abruptly.
In addition to placing a stop-loss order, some investors choose to implement a short-term trading plan. A short-term plan involves using a stop-loss at a specific price level and then waiting for a predetermined amount of time to pass before entering a new trade. Some traders wait two to four hours, while others wait up to eight hours. However, the most successful short-term strategies involve placing a stop-loss at the first possible indicator that signals a short-term sell-off.
Another strategy that traders may utilize is the buy-stop-sell system. The buy-stop-sell system relies on the trader placing a buy order at a specific price level and then waiting for a specified amount of time before entering a new trade. During the time that the buy-order is in effect, the buy-sale system trades the underlying assets in the same manner as the stop-loss strategy. However, if the price rises after the buy-order is placed, then the trader is forced to exit short positions at a profit.