How do you place a stop order, and what is it?
Learn all there is to know about stop orders, how to use them, what they are, and the advantages and hazards of doing so.
What is exactly a stop order?
An instruction to your broker to engage or quit a deal if the market price reaches a specific specified level less favorable than the current price is known as a stop order.
Within a set of constraints, you’ll choose the level at which stop losses will be activated; this level also depends on whether you’re going long or short and entering or departing a trade.
There are two primary stop orders, mainly:
- Order to stop losses
In order to limit potential losses, you exit a transaction when the price swings against you and reaches a specific threshold of loss. If they are positioned higher than the starting point, they may also generate a profit. Your stop loss goes into effect when the predetermined price limit is reached and the position is immediately closed.
Whatever the highest amount of loss you are comfortable with, this will be at a less favorable price than your opening position. By doing this, you may be sure that if a deal goes differently than planned, you will only lose more money than you can afford.
- The stop order will be set lower than the market price if you are purchasing (going long).
- The stop order will be set higher than the market price if you are selling (going short).
- Order of stop-entry
This method is used to open a position when the market reaches a specific level and is the reverse of a stop-loss order.
- Your stop-entry order level will be above the current price if you are purchasing (going long).
- Your stop-entry order will be below the current price if you’re selling (going short).
How are stop orders carried out?
You don’t need to constantly monitor the market to see whether prices will move against you because stop orders are designed to execute automatically. This is particularly helpful in volatile markets where prices move quickly, and you need more time to manually close out a transaction that has gone against you (in the case of stop loss orders) or open one during a limited window of opportunity.
What are the advantages and hazards of stop orders?
Knowing these will help you decide whether or not you should use stops:
ADVANTAGES
- Stop orders reduce your chance of losing money without reducing your opportunity to make money.
- You don’t need to continuously watch your open positions or the market because stop orders are triggered automatically.
- Setting your stop-loss effectively automates when you’ll leave an unfavorable trade, which can help you trade more strategically and reduce the risk of emotional effects.
FINAL INSIGHT
The use of stop orders carries risks. There is no way to alter the stop-loss level once a position has been opened. Therefore, a more conservative stop-loss order than what you are now comfortable with could close the trade before you are ready, for instance, if you grow more bullish as you see a transaction develop.
You risk losing future gains if a transient unfavorable market movement triggers your stop loss, as can happen, for example, when a “dead cat bounce” occurs for an asset you’ve shorted.
