Stop loss is one of the most useful orders for traders, whether you are trading stocks, currencies, commodities, cryptocurrencies or using leverage. In this article, we will introduce you to the tool and the term stoploss, as well as show you in what situations it can be used.
What is Stop Loss?
We can define a stop loss as an advanced exchange order that automatically sells our position after reaching a certain price threshold.
As the name suggests, Stop loss is of great importance in limiting the possible losses of traders when making an unprofitable investment. However, we can also set a stop loss in order to realize limited investment returns.
This concept is used in both short-term and long-term investments. This is an automated order placed through a broker / exchange. The investor orders his broker to sell or buy the selected asset when it reaches a certain price point.
How does stop loss work?
Investors very often decide to use the discussed mechanism to protect the value of their portfolio. Consider the example below:
Investor buys 10BTC for $ 10,000 apiece. At the same time, it sets the Stop loss at $ 9000. If the Bitcoin price starts to fall, the exchange / broker will automatically sell the trader’s position when the price reaches the indicated level. Thanks to this, the user will protect 90% of his capital against further price drops.
There are several benefits to using an order when planning a short-term investment strategy. First of all, as mentioned above, it protects the investor against significant investment losses. In addition, it improves control over your own portfolio thanks to automation – especially when you need to monitor several different transactions at the same time. Despite being an advanced tool, Stoploss is still relatively simple to implement by any investor. In addition, the investor himself can control the level of risk he wants to incur.
Nevertheless, there are also some disadvantages associated with the use of this mechanism. In certain situations, there is a risk that the investor’s position will actually liquidate at a price lower than the set order. This can happen when the price of an asset drops sharply. In this situation, after the order price limit is exceeded, it will only be fulfilled at the nearest possible price threshold. This situation is well illustrated by the example below.
The trader buys 500 Company X shares for $ 100 and sets a Stop Loss order of $ 90. Company X’s share price plummets by 50% due to the disastrous financial report. In this emergency, the Stoploss order is only filled at $ 49.50.
Stoploss and margin trading
The order is gaining importance especially in conditions of increased risk. Margin trading is an environment in which it is definitely worth getting interested in using this tool. If we want to use leverage on platforms such as Binance, BitMEX or Geco.one, we should remember that stop loss can effectively help us control possible losses when trading with leverage.
Moreover, Stoploss will be extremely useful in the event of a negative account balance resulting from the broker’s losses. It is true that the Polish margin trading platform Geco.one protects against such a situation, but in most cases such a risk still exists on the market.