What is a Stop Loss order?
A stop loss buy or sell order is used when you want to buy or sell an asset when it reaches a certain price, commonly known as the stop price.
When the price reaches the stop price for a Stop Loss order, it becomes a market order and buys or sells at the current market price.
Just to reiterate that, Stop Loss order becomes a Market order when the stop price is reached. That’s a key point to remember.
When is a Stop Loss order typically used?
Many traders use stop loss orders in conjunction with take profit orders to manage their open positions. If the asset drops to the stop price the position is closed typically at an expected level of loss, if the asset rises to the take profit price the position is closed for a gain. The difference between these two points often defines the position’s risk-to-reward ratio.
A buy-stop order is commonly placed above the current price, usually above ‘resistance’ levels because traders believe the price will have further up-side from that point on.
A sell-stop order is commonly placed below the current price, usually below ‘support’ levels because traders believe the price will have further down-side below that point. Sell-stops on spot exchanges are also used to limit risk, protect profits and to lock down a maximum potential loss.
It’s really important to note that when the stop price is reached, stop loss orders will execute with a market order type which takes any available market price. If the asset typically has high liquidity this may incur little slippage, but if the asset has very low liquidity it may be worth looking into the stop loss limit order type to avoid possibly taking an unfavorable price and incurring more slippage than expected.
Be sure to weigh the pros and cons order before placing an order of this type.