What Is Stop Loss in Trading? Complete Guide to SL, TP, Types & Examples
Imagine you have placed a trade, got an important call, and suddenly, when you return to see your trade, it turns all red. You made a loss more than your capacity.
Scary situation? Well, you can avoid that just by setting a stop loss. In this blog, we will understand what a stop loss is with examples, types, pros, cons, and how to set the level. This will help you in using the tools effectively
A forex trader can execute a trade at any time. However, the time of trading plays a very significant role in order to earn profit from the trade. Therefore the right knowledge of when does the Forex market open is important to trade.
Retailers can trade in the Fx market from Sunday at 5:00 pm EST to Friday at 5:00 pm EST. However, technically forex market never closes. As there are four forex sessions, and at any point of the day, there is at least one of them open.
The market hours for trade in Forex are from Monday to Friday. Generally, trading stops on weekends as major banks remain closed at that time. However, trading in Forex opens daily, as it is executed over the internet.
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Stop loss and take profit are exit orders. The take profit level is set to exit a trade at a preferred level, booking your desired profit when the trade turns in your favor. A stop loss is exiting a trade at a limited loss when the market turns against you
- Use Risk-to-Reward Ratios
- Use Support and Resistance Zones:
- Use Candlestick Patterns
- Use Technical Analysis Indicators
- Use a Stop Loss Calculator or Expert Advisors
The pips for stop loss depend on the asset you are trading. In the forex market, 20-40 pips is good to set your stop loss.
Ideally, 1:3 is most suitable for risk-to-reward ratios for all sorts of traders.
You can calculate the take profit based on your risk-to-reward or technical analysis tools’ interpretation.
What is Stop Loss in Trading?
A stop loss in trading is a predefined price level at which your trade closes at a limited loss. You may think it is negative, but it’s actually not.
In trading, no one can escape losses. When you place a trade, it will either give you a profit or a loss. The goal is always to make the loss amount as minimum as possible.
And stop loss helps you in doing so. Basically, by using a stop loss, a person sets a limit of loss, and when the trade touches that level, it automatically gets cancelled.
How Stop Loss Works in Trading
Let’s take an example of stop-loss trading. Suppose a trader trades in XAG/USD (Silver vs US Dollar) using a risk-to-reward ratio of 1:3. The trader sets the following trade criteria:
- Buy Entry: $25.00
- Stop Loss (SL): $24.80
- Take Profit (TP): $25.60
- Risk: 20 pips
- Reward: 60 pips
Now, suppose the price touches the level of $25.60, then you will make a profit. But if the market moves against you, let us say the price falls to $20, then you also don’t need to worry, as you have used the stop loss, your trade will automatically close at $24.80.
Types of Stop Loss
Stop loss orders are mainly divided into two parts. Let’s discuss them:
Fixed Stop Loss:
A fixed stop loss is the steady stop loss level. It remains the same even if the market changes.
For Example, you buy GBP/USD at 1.2700 and set a fixed SL at 1.2660. Now, in case your price reaches the stop loss level, it will close your trade.
Trailing Stop Loss:
The trailing stop loss level moves automatically as the market goes in your favour. It protects profit while keeping room for growth.
For Example: You set a 20-pip trailing SL on EUR/USD. If the pair rises 40 pips, the trailing SL shifts up by 20 pips, and if it rises further, the SL will further adjust. You lock profits without fully exiting the trade.
The Scope of Stop Loss:
Forex Market:
Stop loss is a popular tool of risk management in the forex market. All currency pairs, including majors, minors, and exotic pairs, need SL because the market is quite unpredictable sometimes.
Stock Market:
Traders can use a stop loss order while trading with short-term strategies in the stock market.
Crypto Market:
Crypto is highly volatile. Bitcoin can drop 500–1000 points within minutes. This is where a strict SL becomes even more important than in other markets.
Commodity Market:
You can even use stop loss when trading commodities such as Gold, Silver, Oil, and Natural Gas. These commodities can move aggressively during global news, and a stop loss can help you at that time.
Why Should You Use Stop Loss
Using stop loss is not a necessity but a choice. It depends on trader to trader. But even after that, most traders do not place a trade without setting a stop loss. Here are the reasons:
Embrace risk management like a pro:
A stop loss helps you control risk with precision. Instead of relying on emotions or constant monitoring, you predetermine the maximum loss you’re willing to accept, making your trading decisions structured and disciplined.
Have control over your loss:
Stop loss gives you the power to define your downside. Whether the market moves unexpectedly or reacts to news, your losses stay within the limit you set, no surprises, no panic.
Saves your account from blowing:
Many traders blow accounts because they don’t limit losses. A well-placed stop loss prevents one bad trade from wiping out weeks or months of progress.
Keep your trading journey stress-free:
With stop loss orders in place, you don’t have to constantly watch the charts. You can step away from your screen knowing your trade will exit automatically if the market goes against you.
Stay prepared for a negative outcome:
Markets are unpredictable, stop loss keeps you ready. Even if the worst-case scenario happens, you already have a plan to minimize damage and protect your overall trading strategy.
Limitations of Stop Loss
The market can turn in your favor after hitting SL:
One of the most frustrating situations is when the price hits your stop loss and then immediately reverses in your favor.
On the one hand, your stop loss protects you; on the other hand, it can also exit you too early, causing you to miss profitable moves.
Early closing of a trade:
A poorly placed stop loss can close your trade before it has enough room to breathe. Markets don’t move in a straight line; small pullbacks are normal.
If your stop loss is too close, even minor fluctuations can close the trade prematurely, turning a potentially winning trade into a loss.
Too tight or too big stop losses impact the trades:
A stop loss that is too tight increases the chance of being hit often, especially in volatile pairs like XAU/USD or NAS100.
On the other hand, a stop loss that is too large exposes you to unnecessary risk and bigger losses. Both extremes can harm your overall performance, showing why balance and strategy are important when setting SL levels.
How Do You Set Effective Stop Loss Levels?
Setting the stop loss levels efficiently is important; otherwise, it will impact your entire trade. Here are the tactics you can use to set your maximum loss level:
Use Risk-to-Reward Ratios:
Every trader should define the risk-to-reward level. It simply means how much you can afford to lose to earn a decent amount, which is called risk-to-reward. 1:3 is the ideal risk-to-reward ratio that most traders use.
Use Support and Resistance Zones: Support and resistance are key price levels on the chart. Stop loss can be placed beyond these levels, not directly at them.
Use Candlestick Patterns:
Spot patterns like Pin Bar, Hammer, Shooting Star, Bullish Engulfing, Bearish Engulfing, Morning Star, Evening Star, Doji, etc on your chart. They can guide you in setting your trade Stop loss.
Use Technical Analysis Indicators:
You can even go for indicators such as Bollinger Bands, RSI, Moving Averages, and Fibonacci, et,c to place to stop loss level.
Use a Stop Loss Calculator or Expert Advisors: If you are new struggles in setting stop losses, you can use stop loss calculators or trading bots to identify the ideal stop loss level.
Stop Loss vs Take Profit vs Limit Order vs Market Order
Most traders confuse the three major order types. Here is a simple, short, and crisp difference between all three.
Market order is simply to buy or sell an asset at the current price. A limit order is an advanced order in which you set a limit to execute the order at a better price.
Meanwhile, stop loss and take profit are exit orders. The take profit level is set to exit a trade at a preferred level, booking your desired profit when the trade turns in your favor. A stop loss is exiting a trade at a limited loss when the market turns against you.
Basically, market and limit orders help you plan your entries, while stop loss and take profit help you plan your exits.
Conclusion
Stop loss is not optional; it’s a survival tool. Stop loss protects your capital, builds discipline, and keeps you trading long-term. Many traders fear stop loss, but it is the tool that protects you and your account.
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