Do you like losing money?
Of course not! Who does? So stick with me as I explain a very crucial concept if you’re going to be trading.
One of the most important aspects of any trading method is the use of risk control. After you determine the amount you are willing to risk, you need to know how to apply it through the use of a stop-loss. In the simplest terms, a stop-loss is used to prevent you from losing any more of your capital. It is one of the simplest tools that can make all the difference in a trade and almost everyone can benefit from it.
What is a Stop-loss?
Stop-losses are used when trading stocks, option, futures and forex, so it is important to know how to use them correctly. Generally, a stop-loss is an order placed at the time that the trade is entered. It is a tool that is used in trading that will allow you to control your risk by exiting the trade once the price moves against you by a certain amount.
When entering a long position by buying the stock or currency pair, you will place the stop-loss below the entry price. When entering a short position by selling the stock or currency pair, you will place the stop above the entry price. The place where you enter the stop will usually be above or below the prior levels of resistance or support. Once the stop-loss is in place, you can then calculate your position size based off of the risk you are willing to accept in the trade.
The Good and The Bad
As you begin using stop-losses, you will recognize that there are some good, as well as bad, things in using them. One of the good things is that it can give you peace of mind knowing that you have limited your risk. Another good thing is that you don’t have to sit and watch your trades all day. The stop-loss will close your trade even if you are not there.
One of the bad things is that you don’t always know for sure where the best place to put it will be. Sometimes a quick move, even if only for a short time, can make your stop trigger and you will get out of the trade only to find that it continued to move in the correct direction. Another potential bad thing is that if the stock gaps down, you may have a bigger loss than what you expected. With a stop-loss, the trade will be closed at the next available price and if that price is lower than your stop price, it is where you will get filled.
Trailing Stop
One benefit that many brokers and dealers have on their trading platform is a trailing stop. This type of stop is one that moves as the underlying price of the stock or pair moves. Generally, if you set a trailing stop, you will do it to lock in profits as the price moves in a favorable direction. If a stock initially has a $1 stop-loss, and you are trailing it, the stop-loss will continue to move behind the price by $1. This means if you have a $5 move, the stop will now be set so if it is hit, you have locked in a $4 profit.
No matter the type of trader you are, a stop-loss needs to be part of your overall trading plan. By using a stop-loss you can have the confidence that you are limiting your risks as you trade. Although there are potential problems with using a stop-loss, it is still better to use them than not. Take time to practice using stop-losses as a form of insurance and so you can have more confidence in your trading.