What's a StopLoss? and What to Consider When Setting

Stop Loss Order is a type of order that is set after opening a trade that is intended to cut losses if the trading market moves against you.

It is a preset point of closing a losing trade position and it's designed to control losses.

A stop loss is an order placed with your trading broker that will automatically close your trade transaction when it gets to a pre-determined price. When set level is reached, your open position is liquidated.

These orders are intended to cap the amount of money that a trader can lose: by closing transaction if a specific stock price that is against the trade is reached and attained.

Regardless of what you may be told by others, there's no question about it that whether if these orders should or shouldn't be used - they should always be used.

One of the most trouble some things in Indices is setting these orders. Put the stop loss too close to your entry price and you're liable to exit the Stock Index trade due to random market price volatility. Place it too far away and if you're on the wrong side of the market trend, then a small loss could turn in to a big one.

Critics will point out several disadvantages of these orders: that by placing them you're guaranteeing that, should your open trade move in the wrong market direction, you'll end up selling at lower prices, not higher.

Skeptics will also argue that in setting stop losses you are susceptible to exit a transaction just before the trading market heads in your favor. Most investors have had the experience of setting a these orders & then seeing the market price retrace to that level, or just below it, & then go in the direction of their original trend analysis. What may have been a profitable position now instead turns into a loss trade.

Experienced traders always use stop loss orders as they are a crucial part of the discipline that is needed to succeed because they can limit and prevent a small loss from becoming a big one. What is more, by ardently placing these orders whenever you enter a trade, you end up making this important decision at the point in time when you're most objective about what is really happening with stock market, this is because most objective technical analysis is done before entering a trade. After entering trading market a trader will tend to interpret the trading market differently because now they have a bias towards one side, the direction of their market trading analysis.

Unexpected news can come out of the blue & significantly affect the price: this is why it is so important to have a stop loss order. Its best to minimize losses early when a trade is moving against you, it is best to cap your losses immediately instead of waiting it to become a large one. Again, if you put your stop orders when you are opening a transaction, then that is when you're most unbiased.

A key question is exactly where to place this order. In other words, how far should you as a trader place this below your purchase price? Many traders will tell you to set pre-determined - max acceptable loss, an amount that's based on your equity balance rather than use technical stock indicators.

Professional money managers state that you shouldn't lose more than 2% of your account equity on any one trade. If you have got $50,000 dollars in capital, then that would mean max loss that you should preset for any single trade is $1,000.

If you open a trade, then you'd cap your trading risk to no more than $1,000. In which case you would put your stop order at the number of pips that are equal to $1000 & would have $49,000 left in your trading account if you exited the trade position at the maximum loss allowed. The topic of risk management is wide and it's covered in the money management topics.

What to Consider When Setting

Most important question is how close or how far this order should be from the price where you opened the trade position. Where you set will depend on various factors:

Since there aren't any rules set in stone as to where you should set these zones on a chart, we follow general guidelines which are used to help set these levels correctly.

Some of the general guidelines used are:

1. Risk - How much is one willing to lose on a single trade. The general rule is that a indices trader should never lose more than two percentage of the overall total account capital on any one trade transaction.

2. Volatility - this refers to the daily price range. If indices regularly moves up & down in a trading range of 100 pips or more during the course of the day, then you can't put a tight stop order. If you do, you will be taken out of the Stock Index trade by the normal volatility.

3. Risk to Reward ratio - this is the measure of the potential risk to reward. If the trading market factors and conditions are favorable then it is possible to comfortably give your trade position more room. However, if the trading market is too range bound it then becomes very risky to open a transaction without a tight stop then don't make the trade at all. The risk:reward ratio is not in your favor & even putting tight stop loss orders won't guarantee profitable results. It would be more wiser to look for a better trade setup the next time.

4. Position size - if the position size opened is too big then even the smallest decimal stock price movement will be fairly large in % terms. This means that you have to set a tight stoploss order which may be taken out more easily by the market. In most cases it is better to adjust to a smaller trade size so-as-tosothat-to give your trade transaction more space for fluctuating, by placing a fair level for this order while at the same time limiting the trading risk.

5. Trading Account Capital - If your account is under-capitalized then you'll not be able to set your stops accordingly, because you'll have a large sum of money in a single trade transaction which will obligate you to put very close stops. If this is the case, you should think seriously about whether if you have got enough trading capital to trade Index in the first place.

6. Market conditions - If the price is trending upwards, a tight stop might not be necessary. If on the other hand the price is choppy & has no clear trend direction then you should use/set a tight stop loss order or not open any positions at all.

7. Chart Time-Frame - the bigger and larger the timeframe you use, the larger the stop should be. If you were a scalper trader your stops would be much narrower than if you were a day or a swing trader. This is because if you are using longer chart time frames and you determine the price will be move upwards it doesn't make sense to set a very tight stop loss because if the price swings a little, your order will be hit.

The method of setting that you choose will vastly depend on what type of trader you are. The most often used technique to determine where to set is - resistance & support zones. These areas give good points for setting these trade orders as they are most reliable, because the support & resistance levels won't be hit many times.

The technique of how to set these stop losses which you select should also follow the guidelines above, even if not all of those apply to your strategy.

More Topics and Courses:

Trade Stock Indices

What's a StopLoss? and What to Consider When Setting

What to Consider When Setting