One of the best ways to manage your risk when using an online financial trading account is via a stop loss: this is an automatic instruction to close your trade at the price you specify. It means you can limit your loss in advance.
While your online broker may not close the trade at exactly the right price, it will try to close it as soon as it can thereafter. With some share trading accounts there is a fee payable for stop losses, although for CFD trading and spread betting accounts this is free.
Guaranteed Stop Loss Orders
These days, as markets and trading companies become more efficient, brokers are much better at closing trades, often doing so almost immediately.
Some brokers offer guaranteed stop losses, where they promise to close your trade at that price.
Otherwise, there is no guarantee that the trade will be closed at that price: the broker should make every effort to do so, and with more liquid markets like foreign exchange there should be little excuse to fail to do so, but is under no obligation to match the price precisely.
Stop loss orders and your trading strategy
A stop loss lets you decide how much you can afford to lose on a trade. It is important to think about this before you hit the button to open a live trade.
Too many traders spend too much time thinking about the potential profits they could make, without considering the loss they are prepared to accept to get out of a trade. Some traders even trade without a stop loss at all.
By setting a stop loss, you are defining the maximum loss you are prepared to accept, while you are also protecting yourself against sudden market moves while you are away from your trading screen.
Be careful that your stop loss is not too ‘shallow’ however: this means it is too close to the price you go in at, and any small change in the price could trigger your stop.
If you look back over a market’s price history on a chart, you should get a good idea of the recent swings it has been capable off, and be able to set your stop accordingly.
A stop loss is a great way to crystallise your thinking on a trade, particularly the size of the loss you are prepared to tolerate if you are wrong, and whether you can afford to be in that particular market or share at all!
You will sometimes hear traders talking about being ‘stopped out’, meaning their trade was closed automatically when a stop loss was triggered.