One of the most basic skills drilled into newbie traders is the use of stop placement with their buy or sell orders. The staff at NetPicks.com details what a trader should consider before determining whether or not to use them.

The nature of trading is that you win some and you lose some. Knowing when or where you’re wrong therefore can make all the difference between success and failure in this game. Some people struggle with taking a losing trade because they don’t want to lose money. But then many also struggle because they do not have a well-defined exit strategy and so they’re not sure of when they should be exiting for a loss. After all, no one likes being high- or low-ticked out of a trade, do they? So it is that this little seemingly innocuous order type, the stop-loss, throws up so many technical and psychological challenges to deal with before it does what it really should do—protect your account.

The illusion is that the stop-loss order itself is the issue. But it’s merely an order type, which executes at market when the price at which it was placed is traded. Nothing more, nothing less. In reality, the protection offered and the problems created by using this order are generated by the trader. So it is the responsibility of the trader, like everything else in trading, to analyze how a stop-loss order can be used and whether it is appropriate to a specific strategy. By doing so, the trader can have the confidence to stick with the order when a trade results in a negative outcome. Let’s take a quick look at some of the considerations.

PROS

  • You can define what your risk is on an individual trade.

  • Stop orders are lodged at the exchange and so if your power, PC, or Internet goes down or there is a problem with your broker feed, you should be protected against a large move against your position. This can be just as useful if you enter positions using a limit order. If you don’t place a stop order before you’re filled on your entry, then if any of the scenarios outlined above occur while you have resting limit orders in the market, you could be filled on your limit order (again, because the order is lodged at the exchange) and the market could then continue to move against you.

  • Deciding where you will exit a trade before you enter it will help prevent your judgment from being clouded by “in the line of fire” emotions. A physical stop order is a visual reminder of exactly where you’ve determined you’re wrong.

NEXT PAGE: Other Things to Consider