Day traders use several different orders to enter and exit their trades, and one of these orders is a stop loss order. A stop loss is an exit order that is used to limit the amount of loss that a trader will take on a trade, if the trade goes against them. For example, if a trader is in a long trade, they want the price to move upwards, so they will use a stop loss to exit the trade, if the price moves downwards too far.
Stop Loss Types
Stop loss orders are always used to exit trades, and are always used to limit the amount of loss, but some day traders use them as their only exit, while other traders use them as a backup exit only. These two types of stop loss are as follows:
- Regular Exit - When a stop loss is used as the only exit, it is kept close to the current price, at the maximum loss that the trader is willing to accept for a normal trade.
- Backup Exit - When a stop loss is used as a backup exit, it is known as a crash stop loss, or an emergency stop loss, and is kept farther away from the current price, so that it is only filled as a last resort (i.e. if no other exit order can be filled).
Using or Not Using a Stop Loss
Some day traders always use a stop loss (either as a regular exit, or as a backup exit), and some day traders never use a stop loss. There are several reasons why a stop loss should be used, including the following:
- Exiting Quickly - Once a stop loss order has been placed, it is ready to be filled as soon as it is needed, without any additional delay.
- Exiting Automatically - Stop loss orders will exit a losing trade without any further management, including times when the trader is not available (i.e. in the kitchen, on the telephone, outside, etc.).
- Exiting during problems - Stop loss orders can exit a trade during problems that prevent the trader from exiting the trade themselves. For example, if a trader's Internet access is not working, they will not be able to place any exit orders, but a stop loss order will remain in place, and will exit the trade if necessary.
Those day traders that do not use stop loss orders are usually concerned with their stop loss orders being visible in the market, or being caught by unusual price movements that they would normally hold through. These reasons are not enough to justify not using a stop loss, because the reasons for using a stop loss are far more important (e.g. exiting during problems, as described above).
Other day traders that often trade without stop loss orders are scalpers, because they only hold trades for a few seconds. Even then, there is still the potential for a problem that could prevent them from exiting a trade, so even scalpers should use stop loss orders in some form (e.g. long and short stop loss orders far enough away from the current price, and left in place to cover several scalping trades).
Also known as : Stop, Stop Loss Order, Crash Stop