A stop-loss order is a type of order used to limit losses on a position. It is designed to automatically sell an instrument when its price falls to a predetermined level, thereby helping you to manage risk and protect your investments from significant losses.
- Characteristics of stop-loss orders
- How stop-loss orders Work
- Example of a stop-loss order
- Advantages and disadvantages
- How can I place a stop-loss order?
Characteristics of stop-loss orders
- Risk management: The primary purpose of a stop-loss order is to manage risk by setting a predefined exit point for a security. This helps you limit potential losses without having to constantly monitor the market.
- Automatic execution: Once the stop price is reached, the stop-loss order is triggered and becomes a market order. This means the security will be sold at the best available price, which may differ from the stop price due to market fluctuations. Read also: What is a stop-limit order?
- Flexibility: You can set stop-loss orders at any price level, allowing you to tailor your risk management strategy according to your risk tolerance and market outlook.
How stop-loss orders work
For long (buy) positions: A stop-loss order is placed below the current market price for a long position. If the price of the instrument falls to the stop price, the order is activated and becomes a market order, selling the security at the next available price. This helps you exit a position before incurring larger losses.
For short (sell) positions: A stop-loss order is placed above the current market price for a short position. If the price of the instrument increases to the stop price, the order is activated and becomes a market order, buying the security at the next available price.
Example of a stop-loss orderSuppose you own 100 shares of a company currently trading at USD 100 per share. To protect your investment, you set a stop-loss order at USD 90. Let's assume that the stock price drops to USD 90, and your stop-loss order is triggered. Your shares are sold at the best available price, potentially minimising your losses. The market is volatile, and your shares will be sold at the next available price of USD 89.50. While this may be slightly below your stop price, it prevents further losses if the stock continues to decline. |
Advantages and disadvantages
Advantages
- Risk limitation: Stop-loss orders can help you limit losses by automatically selling a security when it reaches a predetermined price.
- Emotional discipline: By setting a stop-loss order, you can avoid making impulsive decisions based on emotions, sticking to your predefined strategy.
- No need for constant monitoring: You can set stop-loss orders and not worry about continuously watching the market.
Disadvantages
- Price gaps: In fast-moving markets, the execution price may be significantly different from the stop price due to price gaps, leading to unexpected losses.
- Temporary price fluctuations: A stop-loss order might be triggered by a short-term fluctuation, resulting in the sale of a security that might recover quickly.
How can I place a stop-loss order?
- New positions: To set up a stop-loss on the trade ticket for a new position, click Add Take profit / Stop loss > Select a price by Stop Loss > Click Place order to finalise the trade
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Existing positions:
- To set a stop-loss order on an open position, simply right-click on the position > Click Take Profit / Stop Loss > Insert the desired price > Click Place order.
- In SaxoTrader, you can also click Add under Stop in the Positions module.
Learn how to place a stop-loss order in this short video.