Why Stop-Loss Orders are Critically Important in Trading

    When you’re trading there are numerous factors that are at play and can influence whether you make a profit or loss. However the one all-important factor that can help you avoid making too much of a loss is the often-overlooked stop-loss order.

    Essentially a stop-loss order is an order that is placed to sell (or buy) the stock when a certain limit is reached. In other words if you set your stop-loss order at 10% below the current price which you bought a stock then it would trigger if the price falls by 10% and sell the stock – thus limiting your losses to 10% at most.

    Importance of Stop-Loss Orders

    Knowing what stop-loss orders are, it should be clear that the main reason why they are so important is that they can help you to avoid making heavy losses when trading. Because stop-loss orders are automatically executed when they reach a limit, you don’t need to be constantly monitoring the market activity and can rest easy knowing that they will kick in.

    Many new traders often also use stop-loss orders as a way to prevent themselves from ‘holding on’ to positions that are losing value. The temptation to wait out some price drops in the hope that it will rise again is often very strong – and having a stop-loss order can help ensure that you don’t give in to it.

    How to Set Effective Stop-Loss Orders

    In order to reap the benefits of stop-loss orders, you will need to be mindful of the limits that you set. More specifically your limit should be outside of the ‘normal’ range of fluctuations. For example, if the market price fluctuates by up to 10% of the average on a daily basis then setting it at 10% or lower could be more hindrance than help. Instead, a limit of 15% below the average may be more reasonable.

    Another factor to take into account when setting stop-loss orders is your leverage. Because stop-loss orders are based on the market price, if you are taking on a leveraged position then you will need to factor that in. For example a 10% drop in the market price would mean a 10% loss in capital on an unleveraged position, but on a 5:1 leverage it would mean that you’re losing 50% of your capital.

    Setting stop-loss orders carefully after taking into account the market conditions and trends will help you to ensure that you gain the advantages that come along with it while avoiding most of the pitfalls. Overall when you start to set stop-loss orders (and stick by them) you will find that you are able to curtail your losses substantially.

    If you want to start trading on multiple different markets, be sure to head over to ETX Capital. It will let you take on positions across various equities, commodities, indices and forex pairs – as well as other financial instruments. Just remember to take advantage of stop-loss orders when you do start trading.

    This article does not constitute investment advice. Please see our full disclaimer.

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