A stop loss is a type of order that instructs your broker to close your position automatically if it reaches a certain price point which is less favourable than the current price.
There are three main types of stop you might want to use when trading the markets. Here’s an introduction to each of them.
The most common form of stop, the basic stop (also known as a stop loss order) will close out your position when a specified price is reached.
Say, for example, that you’ve opened a long position on 10,000 ABC shares when they are priced at 37c, with a stop loss at 32c. If ABC’s share price drops below 32c, your stop loss will trigger and limit your loss to $500 (10,000*5c).
However, basic stops won’t always close you position at exactly the level you specify. Gapping or slippage – when we can’t place your trade at your specified level due to high volatility – could see your position closed out at a worse price than the one you expected.
One way to ensure your stop is executed exactly where you specified is by placing a guaranteed stop. Guaranteed stops work in the same way as basic stops, except that they will always be filled at exactly the level you set: even if gapping or slippage occurs.
If your guaranteed stop is triggered, though, it will incur a fee on the trade.
Trailing stops not only help you limit your losses, they can also protect any profits made from the same position.
Instead of setting your stop at a specific price, trailing stops are set a number of points away from the current price of your position. Then, if your position moves in your favour, the stop will move with it. If your gains are then reversed, your stop will be triggered at its new level, closing the position before your profits are erased. But remember, trailing stops are not guaranteed and are susceptible to slippage.