What's a Indices Stop Loss Trading Order? and Factors to Consider When Setting

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

It is a preset point of closing a losing trade transaction 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 reaches a predetermined price. When set level is reached, your open trade is liquidated.

These orders are intended to restrict the sum of money that trader can lose: by exiting the transaction if a specific stock price that's against the trade is reached.

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

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

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

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

Experienced traders always use stop loss orders as they are an important part of the discipline that is required to succeed because they can prevent a small loss from becoming a big one. What's more, by ardently placing these orders whenever you enter a position, 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 the most objective technical analysis is done before entering a trade position. After entering the trading market one will tend to interpret the trading market differently because they have a bias towards one-sidea-particular-side, the direction of their market technical 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 cap losses early when a trade position 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're opening a trade transaction, then that is when you are most unbiased.

A key question is exactly where to place this order. In other words, how far should you place this below your purchase price? Many traders will tell you to set predetermined - maximum acceptable loss, an amount that's based on your account 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 $50,000 in trading capital, then that would mean max loss that you should preset for any single trade is $1,000.

If you opened a trade, then you would 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 transaction at the maximum loss allowed. The topic of Indices risk management is wide & it is covered in the money management topics.

• Indices Money Management Introduction
• Indices Trading Money Management Methods

Factors to Consider When Setting

Most important question is how close or how far this order should be from the price where you entered the position. Where you set will depend on several 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 one transaction. The general rule is that a trader should never lose more than 2 percent of the total account capital on any one 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 cannot put a tight stop order. If you do, you will be taken out of the trade transaction by the normal volatility.

3. Risk to reward ratio - this is the measure of potential reward to risk. If the trading market conditions are favorable then it is possible to comfortably give your trade more room. However, if the trading market is too choppy it then becomes too 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 will not guarantee profitable results. It would be more wiser to look for a better trade position 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 stop loss order which may be taken out more easily by the market. In most cases it's better to adjust to a smaller trade position 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 risk.

5. Account Capital - If your account is under-capitalized then you will 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 you've enough capital to trade Stock Indices 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 direction then you should use a tight stop loss order or not open any positions at all.

7. Chart Time Frame - the bigger the chart timeframe you use, the bigger the stop should be. If you were a scalper trader your stops would be tighter than if you were a day or a swing trader. This is because if you're using longer chart timeframes and you determine the price will be move up-wards 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 select will vastly depend on what type of trader you're. The most commonly used technique to determine where to set is - resistance and support zones. These areas give good points for setting these trade orders as they are most reliable, because the support and resistance levels won't be hit many times.

The technique of how to set these stops that you select should also follow the guidelines above, even if not all those who apply to your trading strategy.