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Stop Loss
A stop-loss order is a type of conditional order in financial trading that automatically closes a position when the asset reaches a specified price.
Purpose:
- To limit potential losses on a trade.
- To protect capital from significant decline.
- To manage risk and avoid catastrophic losses.
How Stop-Loss Orders Work:
- Setting the Stop-Loss Price: The trader specifies the stop-loss price at a certain level below the entry price.
- Triggering the Order: If the asset price reaches the stop-loss price, the order is executed, closing the position at that price.
- Exit at Stop-Loss: The position is exited at the stop-loss price, regardless of whether the trader has manually placed an order to close it.
Types of Stop-Loss Orders:
- Market Stop: The order is executed at the best available price in the market at the time of triggering.
- Limit Stop: The order is executed at the specified stop-loss price if it becomes available in the market.
- Trailing Stop: The stop-loss price is moved along with the asset price when the asset moves in your favor.
Advantages:
- Provides a clear exit point in case of a loss.
- Limits potential losses.
- Can help manage risk.
Disadvantages:
- May not be able to get the best possible price if the market moves rapidly against you.
- Can be emotionally difficult to see your position closed against your will.
- May not be suitable for complex trading strategies.
Best Practices:
- Place stop-loss orders with enough buffer to account for market volatility.
- Use trailing stop-loss orders to lock in profits as they increase.
- Review stop-loss orders regularly to ensure they are still active.
- Consider the overall risk tolerance and objectives of your trading strategy when setting stop-loss prices.
Example:
You buy an asset for $100 and set a stop-loss order at $90. If the asset price drops to $90, your stop-loss order will close the position at that price, limiting your potential loss to $10.
