One of the most significant tools several traders swear by is a “stop-loss order”. Experienced traders consider it to be necessary especially when you begin trading. Stop losses order can be triggered in all trades.
This blog will present a critical analysis of stop-loss orders as it discusses the benefits and the drawbacks of stop-loss orders to help traders make an informed decision on whether or not they should opt for this facility. Though we at GTC encourage you to apply a stop-loss order to every single trade, eventually it is your decision.
Knowing how to use a stop-loss order isn’t the only point, you must know which level to place them at. And doing so can either make or break a trade. So without further ado let’s dive into why you should use stop loose.
What is a stop-loss order?
A stop-loss order is a risk management tool, that traders use to mitigate their losses and limit risk exposure. When a stop order has been applied a trader can exit a trading position if the price goes below a specific level. Doing so helps the trader limit losses.
Why do some experienced traders not use a stop loss?
Though Stop losses are used to mitigate risks, certain traders think otherwise. In order to understand why traders who do not prefer to stop losses avoid them, it is necessary to understand how they work. So if a trader has set his stop loss at 5% and the investment tends to stock drop 20% the stop loss is triggered but, the trader will not end up selling since there is no bid at the mentioned limit.
So even though the stop order will have occurred but since there is nothing to match the bid limit the trader will still own the security.
Why you should use a stop loss?
According to research conducted in 2004, stop losses applied over a period of 54 years were studied. The results showed that stop losses applied in the stock market, higher gains than bonds were achieved 70% of the time. It was further found that losses incurred were substantially reduced when a stop-loss order was applied.
Another research conducted in 2009 showed that The highest cumulative returns were earned under a 15% stop loss. After this several other studies showed similar results.
If this isn’t convincing enough, then let’s debate the reasons why you should use a stop loss.
Life Jacket During Volatile Situations
Stop-loss orders help prevents uncontrollable losses in uncertain or volatile scenarios. During such situations, a stop-loss order can help traders save themselves from losing most of their trading profits.
Helps You Grow Your Account
If as a trader one is serious about the growing portfolio it is necessary to apply for a stop-loss order. It isn’t easy to monitor all your assets during the day, hence applying a safety net like a stop-loss order can save you from a large amount of loss and you can continue to build your portfolio.
Type pf stop losses
Several types of stop-loss orders can be applied to one’s account according to one’s risk management strategy. These stop-loss orders are briefly mentioned below,
- Chart Stop
- Volatility Stop
- Time Stop
- Percentage Stop
- Trailing Stops
Each stop-loss order is beneficial for a different trading strategy. A trader places must stop losses at significant support & resistance zones. On the other hand, traders using a rend-following strategy should apply trailing stops. Traders are also suggested to calculate the size of their positions based on their stop losses and their profit target should always be greater than their stop loss.
Most studies showed results that favored the use of a stop-loss order. However, in rare cases, a stop-loss order only hindered the trade. Nonetheless, only experienced traders were seen to gain some success without the use of a stop-loss order. A stop-loss order being a risk management technique saves traders from higher losses which is why we advocate the use of this technique.