What is a StopLoss Order? & Factors to Consider When Setting

Stop Loss Order is a type of order which is positioned after opening a trade that is meant to cut losses if the market trend moves against you.

It is a predetermined point of exiting a losing transaction & it's meant to control losses.

A stop loss is an order placed with your stocks broker that will automatically close your stocks trade transaction when it reaches a predetermined price. When the set level is reached, your open trade is liquidated.

These stocks orders are intended to restrict the sum of money that trader can lose: by exiting the transaction if a specific price that is against the trade is reached.

Regardless of what you may be told by others, there's no question about if these orders should or should not be set - these orders should always be set.

One of the most troublesome things in in Stocks is setting these orders. Put the stop loss too close to your entry price & you are liable to exit the trade transaction due to random market volatility. Place it-toothe-stop-loss-order-too far away & if you are on the wrong side of the market trend, then a small loss might turn into a large one.

Skeptics will point out several disadvantages of these orders: that by placing them you are guaranteeing that, should your open position move in the wrong direction, you will end up selling at lower stocks prices, not higher.

Skeptics will also argue that in setting stops you are vulnerable to exit a transaction just before the market moves in your favor. Most investors have had the experience of setting a these orders & then seeing the price retrace to that level, or just below it, and then go in direction of their original market trend analysis. What might have been a profitable trade position now instead turns into a loss trade.

Experienced traders always use stop orders as they are a crucial part of the discipline that is required to succeed because they can prevent a small loss from becoming a big one. What's more, by ardently placing these orders whenever you open a trade transaction, you end up making this important decision at the point in time when you are the most objective about what is really happening with the market, this is because the most objective analysis is done before opening a trade transaction. After opening the market a trader will tend to interpret the market differently because now they have a bias towards one-sidea-particular-side, the direction of their market analysis.

Unexpected news can come out of the blue & dramatically affect the price: this is why it's so crucial to have a stop order. Its best to cut losses early when a trade transaction is going against you, it's best to cut your losses immediately instead of waiting it to become a large one. Again, if you put your stop orders when you're opening a trade transaction, then that is when you are most unbiased.

A key question is exactly where to place a this order. In other words, how far should you place this below your purchase stocks price? Many traders will tell you to set a pre-determined - max acceptable loss, an amount that is based on your account balance rather than use indicators of the instrument in question.

Professional money managers state that you shouldn't lose more than 2% of your account equity on any one stocks transaction. If you have $50,000 in capital, that then would mean the max loss you should set for any single transaction is $1,000.

If you bought 1 standard lot of a instrument, then you would cap your trading risk to no more than $1,000. In which case you would put your stop order at 100 pips (points) & would have $49,000 left in your trading account if you exited the trade position at the max loss allowed. The topic of risk management is wide and it's covered in the money management topics.

• Stock Money Management Introduction
• Stock Money Management Methods

Factors to Consider When Setting

The most important question is how close or how far this order should be from the price where you entered the position. Where you set will depend on several factors:

Since there aren't any rules cast in stone as to where you should place these levels on a chart, we follow general guidelines that are used to help put these levels correctly.

Some of the general guidelines used are:

1. Risk - How much is one willing to lose on a single transaction. General rule is that a trader should never lose more than 2 percent of the total account capital on any one single transaction.

2. Volatility - this refers to the daily price range of a stocks. If a instrument regularly moves up & down in a range of 100 pips or more during the course of the day, then you cannot put a tight stop order. If you do, you will be taken out of the trade position by the normal market volatility.

3. Risk to reward ratio - this is the measure of potential reward to risk. If the market conditions are favorable then it's possible to comfortably give your trade more space. However, if the market is too choppy it then becomes too risky to open a transaction without a tight stop then don't make the trade at all. The risk to reward isn't in your favor & even putting tight stop loss orders will not guarantee profitable results. It would be more wiser to look for a much better trade transaction next time.

4. Position size - if the position size opened is too big then even the smallest decimal price movement will be fairly large in percentage terms. This means that you have to put a tight stop loss which might be taken out more easily. In many cases it's better to adjust to a smaller trade transaction size so-as-tosothat-to give your trade transaction more room for fluctuation, by putting a rational level for this order while at same time capping risk.

5. Account Capital - If your account is under-capitalized then you will not be able to set your stops accordingly, since you will have a big sum of money in a single trade position which will constrain you to set very tight stops. If this is case, you should think seriously about whether you have enough capital to trade Stocks in the first place.

6. Market conditions - If the price is trending up-ward, a tight stop might not be necessary. If on the other hand the price is choppy & has no clear market trend direction then you should use a tight stop loss or not execute any transactions at all.

7. Chart Time-Frame - the bigger the chart time-frame you use, the bigger the stop should be. If you were a scalping your stops would be tighter than if you were a day or a swing trader. This is because if you are using longer chart time-frame & you determine the price will be move up it doesn't make any sense to put a very closetight stop loss because if the price swings just a little, your order will be hit.

The technique of setting that you choose will significantly depend on what type of trader you are. Most oftenly used method to determine where to set is - resistance & support levels. These regions give good points for putting these stop loss orders as they are the most reliable zones, because the support & resistance levels will not be hit many times.

The method of how to set these stops that you choose should also follow the guide-lines above, even if not all those who apply to your stocks strategy.