When your bucket is overflowing with water, what do you do? The answer is simple. You turn off the tap. That way water stops overflowing and you don’t need to worry about the bills so much. Just like this situation, traders use a system to prevent their capital from being lost.
This unique system is known as stop-loss. Even though it sounds a bit complicated to beginners, once you understand it, it will be very easy to master it. There are different aspects of stop loss to be considered while trading and today we are going to explore aspects of the system known as ‘stop-loss’.
What is stop-loss?
The stop-loss is a mechanism where an investor can set the loss limit and if the trade faces loss, the loss stops at the limiting point by closing the trade.
For example, let’s imagine that you traded at $120 and set a stop-loss point at $118. After trading, you saw that this investment has failed and you started losing your money. But since you set a stop-loss, the loss will limit itself at $118 without going downward while calling an end to the trade.
Even though stop-loss can be used in both short-term and long-term trading, it is the most effective in day trading. In day trading, trading opens and closes within a single day. Usually, the stop-loss limit is set at the amount of profit made from the previous working day so that any losing days can easily be covered by a winning day. Thus, your invested capital remains safe.
A stop-loss deals with the risks of trading and helps to reduce the loss in a trade. Stop-loss is used if any investment goes in the wrong direction and hits the level previously determined to prevent potential losses. Read more about the protective stops at Saxo and reinforce your investment security.
The majority of long-term traders are often quite skilled and more experienced than day traders. They remain aware that the market fluctuation is just a normal case scenario and based on their research they can sense whether the trend will stay or not. Since they tend to stick to their research and technical analysis, it is mostly worthless to use a stop-loss.
Traders use many tools to help them identify a good deal and for technical analysis in trading. Stop-loss is one of these tools and a very powerful one indeed. It falls among the top-tier tools that are used by traders frequently. You can say, it is one of the most elite trading tools out there.
That is why it is one of the basics that you need to master to do a good job in the trading platform.
Advantages of stop-loss
- Your losses are limited automatically without the need for your surveillance. So even if you remain off guard, it doesn’t matter much since the stop-loss is automated once it is set.
- It helps to maintain the risk-reward ratio by fixing a certain amount of risk. While trading, traders take a certain percentage of risk to make an equal amount of profit, and stop-loss aids in controlling that risk.
- One of the many uses of stop-loss is that it doesn’t let your loss turn bigger. In a trading platform, a small loss is always profitable than any bigger loss. When you set a stop-loss, it tends to limit your loss. Without it, your loss rate would have gotten bigger than you wanted it to be. In that way, stop-loss helps you save some pennies from losing trades.
- Setting a stop-loss makes you aware of your limitations as a trader and enables you to take the right decision of taking risks per trade. Stop-loss reduces extravagancy in trading.
However, you should also be aware that your stop-loss might not work or function properly if it is not applied in the right manner. Whenever such a problem arises, try contacting the owner to learn the reason behind it and fix it as soon as possible before any big losses erode your ten days’ worth of profit.