Managing risk with stop-loss orders
It’s impossible to monitor positions for every minute that you have a trade open but stop-loss orders can help to mitigate risk the next time you leave for vacation, lunch, or even just the bathroom. Learn what stop-loss orders are, how they work, and how to use them.
What is a stop-loss order?
Stop-loss orders aim to limit risk by exiting positions at predetermined distances from your entry price – often measured in tick increments like pips or notional amounts of losses. Traders can attach stop-loss orders to long or short positions at order entry with the goal of closing the position if a certain level is breached.
Stop-loss orders trigger a closing market order – sell at the best available price for long positions or buy at the best available price for short positions – when the market has moved a set distance against you.
Stop-loss order example
Let’s say you want to go long 1 lot on EUR/USD with an attached stop-loss order to close the position if the market falls 100 pips. You’ve conducted your own analysis and believe that EUR/USD will go up by 100 pips, where you want to take profits, but you do not want to lose more than you would potentially profit if your analysis is incorrect.
If you enter the position at 1.0745, then the stop-loss order will trigger a market order to close the position if EUR/USD falls 100 pips to 1.0645. However, if EUR/USD does not trade down to 1.0645 or lower, then the position will continue to fluctuate in your account until you close it.
If EUR/USD rises to 1.0845 before trading down to 1.0645, then you can close the position for your predetermined profit amount—100 pips. You can also set a take-profit amount on the order ticket for 100 pips that will trigger a market order to close the position if the market trades up to 1.0845.
Depending on the movement in the market, the resulting profit or loss will take effect in your account automatically if the stop-loss and take-profit orders are set. If 1.0645 is hit first and the triggered order closes the position for exactly 100 pips in losses on the 1-lot position, then a -$1,000 loss will display in your account. If 1.0845 is hit first and the triggered order closes the position for exactly 100 pips in profits on the 1-lot position, then a +$1,000 profit will display in your account.
(Example excludes potential fluctuations due to overnight funding rates or fees. Also note that setting a normal stop-loss does not guarantee that your stop loss will be executed at that exact level. If the market moves suddenly past the point at which your stop loss has been set, it could be fulfilled at a worse price than your stop loss amount due to slippage.)
How to use a stop-loss order
Stop-loss orders can be entered at the same time as order entry often in the form of a percentage, notional amount, or tick increment difference from where the position is entered. For example, a $100 stop-loss order can be attached to a new long or short position that will attempt to close the position if its profit/loss falls to -$100.
The individual trader should consider what risk amount fits their account and appetite before entering into a position and choose a stop-loss order distance that makes sense for them. This can help to take surprise and emotion out of day-to-day trade making more time for analysis and new opportunity.
Can this new position withstand:
- a -$500 loss?
- a -3% loss?
- a -200 pip loss?
Stop-loss order benefits
Risk management tools like stop-loss orders seek to measure and reduce large potential losses before they occur. Stop-loss orders attempt to close positions at predetermined levels without a trader having to monitor the market and manually enter the closing order, which can help to reduce potential human errors while creating a more mechanical, strategic process.
Benefits of stop-loss orders:
- Reduced emotions like stubbornness that can lead to large losses the trader did not intend from the position’s start
- More time spent on new trading, or non-trading, opportunities and strategies
- Set mechanics and strategy based on consistent, predetermined profit and loss amounts from trade to trade
What is a trailing stop order?
Trailing stop-loss orders incorporate a dynamic aspect to the normal stop-loss order whereby the distance set at order entry moves with the position as it becomes more profitable. Trailing stop orders on long positions, for instance, bring the stop-loss order attached to the position higher if the market moves higher and thus in the trader’s direction.
Trailing stop order example
For example, entering a market order to buy EUR/USD at 1.1020 with a stop-loss order attached 100 pips away and a trailing step of 10 pips would attempt to close the position if the market broke below 1.0920 if the market moved lower immediately; however, the stop-loss level would rise by 10 pips every 10 pips that the position gained in profits. If the market moved to 1.1030, then the stop-loss level would effectively move to 1.0930, and so on.
How to trade forex with stop-loss orders
- Choose the forex market you’d like to trade
- Open an account to get started, or practice on a demo account
- Choose your forex trading platform
- Open positions with stop-loss orders
Trading forex markets using stop-loss orders requires an account with a forex provider like tastyfx and a strategy. Most strategies applicable to trading in other markets can be used to trade forex as well, including technical and fundamental analysis.
Once your strategy is developed, you can follow the above steps to opening an account and getting started trading forex.
Your profit or loss is calculated according to your full position size. Leverage will magnify both your profits and losses. It’s important to manage your risks carefully as losses can exceed your deposit. Ensure you understand the risks and benefits associated with trading leveraged products before you start trading with them. Trade using money you’re comfortable losing.
This information has been prepared by tastyfx, a trading name of tastyfx LLC. This material does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. You should not treat any opinion expressed in this material as a specific inducement to make any investment or follow any strategy, but only as an expression of opinion. This material does not consider your investment objectives, financial situation or needs and is not intended as recommendations appropriate for you. No representation or warranty is given as to the accuracy or completeness of the above information. tastyfx accepts no responsibility for any use that may be made of these comments and for any consequences that result. See our Summary Conflicts Policy, available on our website.
