A:

Stop-loss orders are placed by traders either to limit risk or to protect a portion of existing profits in a trading position. Placing a stop-loss order is ordinarily offered as an option through a trading platform whenever a trade is placed, and it can be modified at any time.

Traders customarily place stop-loss orders when they initiate trades. Initially, stop-loss orders are used to put a limit on potential losses from the trade. For example, a forex trader might enter an order to buy EUR/USD at 1.1500, along with a stop-loss order placed at 1.1485. This limits the trader's risk of loss on the trade to 15 pips.

Once a trade is showing a moderate profit, a trader commonly adjusts the stop-loss order, moving it to a position where it protects part of the trader's profits in the trade. Continuing with the previous example, assume that after the trader buys EUR/USD at 1.1500, the price subsequently goes up to 1.1600. At that point, the trader may move his or her stop-loss order up to 1.1540, thus protecting almost half of his or her existing profit in the event the market turns down.

Traders sometimes use trailing stops to automatically advance their stop-loss order to a higher level as the market price rises. Trailing stops are easily set up on most trading platforms. The trader simply specifies the number of pips, or dollars, that he or she wishes the stop order to trail behind the market high. Still using the EUR/USD example, if the trader specifies a 50-pip trailing stop, when the market reaches 1.1600, the stop will automatically shift to 1.1550. If the market then rises to 1.1620, the stop will be advanced higher to 1.1570.

Stop-loss orders are a critical money management tool for traders, but they do not provide an absolute guarantee against loss. If a market gaps below a trader's stop-loss order at the market open, the order will be filled near the opening price, even if that price is far below the specified stop-loss level.

RELATED FAQS
  1. What is the difference between a buy limit and a sell stop order?

    Understand the differences between the two order types, a buy limit order and a sell stop order, and the purposes each one ... Read Answer >>
  2. How do I determine where to set my stop loss?

    Read about some theories on stop-loss placement and how traders use stop-loss orders to hedge against losses and capture ... Read Answer >>
  3. Do Stop or Limit Orders Protect You Against Gaps?

    Regardless of the type of stock order you place, there's no surefire protection against gaps. Read Answer >>
  4. What happens to a stop order after a stock splits?

    A stop order (or stop-loss order) is executed when a security reaches a pre-determined price as a market order. Learn what ... Read Answer >>
  5. The difference between a market order and limit order

    Market orders execute a trade to buy or sell immediately at the best available price. A limit order only trades when the ... Read Answer >>
Related Articles
  1. Trading

    The Stop-Loss Order - Make Sure You Use It

    It's a simple but powerful tool to help you implement your stock-investment strategy. Find out how.
  2. Investing

    Stop Loss Order Strategy

    A stop loss order is an order placed with a broker to sell a stock immediately if it drops to a certain price. It's a common way for investors to protect themselves from the possibility of a ...
  3. Investing

    Are Stop-Loss Orders and ETFs a Good Idea?

    When it comes to stop-loss orders, your approach should depend on whether you’re trading ETFs or individual stocks. Learn more in this article.
  4. Trading

    Can These Momentum Stocks Break Out One More Time?

    Here are some levels to watch for another breakout in these high-momentum stocks.
  5. Trading

    Increase Your Profits With Soft or Mental Stops

    A soft stop provides traders with added flexibility, allowing them to react to the market.
  6. Trading

    Use Stops To Protect Yourself From Market Loss

    Master these simple risk management strategies to protect your portfolio or trading account from large losses.
RELATED TERMS
  1. Stop-Loss Order

    A stop-loss order is an order placed with a broker to sell a ...
  2. Discounted Stop-Loss Cover

    Discounted stop-loss cover is a reinsurance agreement used by ...
  3. 2% Rule

    The 2% rule is a money management strategy where an investor ...
  4. Protective Stop

    A protective stop is a strategy designed to protect existing ...
  5. Day Order

    A day order automatically expires if not executed on the day ...
  6. Gapping

    Gapping is when a stock opens significantly above or below the ...
Trading Center