Stop losses are one of the most important things you will need to know about when you are trading, and whilst there are things to look out for as far as where you set your stops, you should not disregard setting a stop loss if you are taking prudent risk management into account!
In this guide, we are going to run through the basics of stop losses, how to set them, when to use stop losses for locking in profit taking, and some FAQs we have seen surrounding the subject of stop losses.
What are stop losses and how do they work?
A stop loss is an order placed with a broker (or trading platform) to sell a security when it reaches a certain price. This is done to limit your losses in the event that the price of the security falls sharply. You can set stop losses for any type of instrument, providing the broker or trading platform supports it.
It is very common for people day trading, or anyone using technical analysis, to set stop losses particularly during periods of high volatility, and to remove the desire to stick with a trade when it is going against you. Whether trading stocks, forex, commodities, or crypto stop losses are one of the basic things you will want to know how to implement properly in order to manage risk.
There are two types of stop losses: absolute and relative. An absolute stop loss is set at a specific price, while a relative stop loss is set as a percentage of the current price, commonly referred to as a trailing stop loss.
How to set a stop loss order
To set a stop loss order, you will need to log in to your broker’s trading platform and find the security you want to trade. Then, you need to select “order type” and choose “stop loss”.
You will then need to enter the price at which you want to place your stop loss order. If you are placing a relative stop loss, you will need to enter the percentage of the current price.
It is also possible to set a trailing stop loss, which is a stop loss that moves as the price of the security moves. To do this, you will need to set the “trailing amount”.
Once you have entered all the relevant information, you will need to click “submit” or “place order”.
You can see an example of this in the image below from Trading 212, where you can set your stop loss, take profit level, and choose between definitive or trailing.
Common Questions about Stop Losses & When To Use Them
Why use a stop loss, and when would it be appropriate?
A stop loss is used to limit your losses in the event that the price of a security falls sharply. This is particularly important during periods of high volatility.
Stop losses are not foolproof, however, and can be triggered by sudden market moves or order imbalances.
In general, it is a good idea to use a stop loss if you are day trading and do not have the time to monitor your positions constantly. This will help you to manage your risk and avoid large losses.
Do stop losses work after hours?
It depends on your broker. Some brokers will allow you to place stop losses on after-hours trades, while others will not but this is usually aligned with whether your chosen broker actually supports pre or post market trading at all.
A broker that allows you to buy and sell in the pre market or after hours, will also usually allow you to implement a stop loss that will trigger after hours. If your broker does not allow purchases during pre market or during after hours trading, then your stop loss will usually not work after hours either.
What if the stock gaps below my stop loss price?
If the stock gaps below your stop loss price, your order will usually be executed at the next available price, which may be lower than your stop loss price.
Gapping can occur for a number of reasons, including earnings announcements, news releases, or regulatory changes.
Stop Loss and profit taking
Profit taking, and knowing when to take your profits and walk away from a trade can be the difference between a successful trader, and an unsuccessful one.
When it comes to profit taking, there is no single answer that fits all situations. Ultimately, you will need to use your own judgement to decide when to take your profits and walk away but using a stop loss to lock in profits can never be considered a bad move. This is also the same for using take profit orders, to exit positions when the upper level price target has been reached.
There are a few things you can keep in mind, however, that may help you make the decision. We are going to identify these three times where you should definitely use stop loss for profit taking.
1.When you hit your predefined price target
First, you should have a profit target in mind before you enter a trade. This will help you to know when to take your profits and exit the trade. If price action has moved you into a position of greater profit than anticipated, you should consider hard whether you should stay in the trade, even if you want to.
If you are adamant that there is more on the table, consider setting a stop loss to take profits at a level you are happy with so as not to see your profits eroded by a bad call.
2.Market conditions and macro trends are against you
Second, you should pay attention to market conditions and general fundamental analysis. If the market is starting to look bearish (or against your trade), it may be time to take your profits and exit the trade. Again you can decide whether that should be done imminently, or by using a stop loss at a level you are comfortable with.
3.When your emotions are not where they should be
Third, you should monitor your own emotions constantly when trading as a matter of habit. If you are starting to feel greedy or anxious, it may be time to take your profits and exit the trade as it will become more difficult at these times to trade using logic and thought. This is where having a predefined strategy comes in handy.
If you are noticing emotions getting the better of you, consider some time out from trading, and take a break. Trading psychology is a critical element, and should not be overlooked.
4.If you are not completely happy with the risk profile of the trade
Remember that you can always exit a trade if you are not comfortable with the risk at any time. There is no shame in taking your profits (or a loss) and walking away if you are not comfortable with the potential for greater loss.
One of the arts of successful trading over a longer timeframe is being able to take the losses consistently, but trying to manage them and keep them smaller than your wins. If you can do that systematically, you will be a far more successful trader than 90% of those out there!
Failure to use stop losses due to fear of stop loss hunters is not prudent risk management
Stop losses are not foolproof, and can be triggered by sudden market moves or order imbalances before a trend continues in the previous direction, causing you to miss out on what might have seemed like a profitable trade.
If is important therefore to set your stop loss at a level that you feel comfortable with, and not any lower than a point which would be outside of your risk management plan. If your stop loss is hit, then so be it, at least your account is still in play and you can continue to trade again another day, with a different setup.
Every one of the trusted trading resources on trading will in some way emphasize the importance of stop losses and take profit orders.
A big part of the trading battle is sticking around, and taking advantage of the moments when they come. You cannot do that if your account has been blown up by poor risk management.
Stop Loss Hunting is not as common as you think
There are also many that talk of stop loss hunting and the fear of setting stop losses in case it gets hit by those trying to push you out of your position. Can it happen? yes. Are there ways to avoid it? yes.
One way to potentially avoiding stop loss hunters is to avoid setting your stops at exact round numbers, or the exact level of support or resistance. These are the levels that many stop loss hunters will target to take out a proportion of trades, usually before a potential reversal sets up. This will not always be the case however, but is also not an excuse for not setting stop losses.
Your particular position as a retail trader will likely be too small for anyone searching for stops to care about. These are usually institutional players, looking to position themselves in the market at a low price, or to push the price below a key level, and your position is unlikely to sway them one way or another.
Consider your stop being hit as a sign you are doing the right thing, and if you keep doing the right thing then your account balance will over time grow; that is assuming you also exercise proper risk management when you are profit taking!