When making market investments, traders seek to limit potential losses using various orders. The different order types allow investors to get in and out of the market at specific times where manual orders may not work. The dynamic nature of crypto marketplaces makes manual orders cumbersome. Stop-loss orders are a valuable tool for traders in efficiently managing their portfolios and help them cope during difficult times.
Let’s look at how they work and their different types to better understand their use in the market.
What Is A Stop-Loss Order?
A stop-loss is a special market order that closes a position automatically once a certain price level is reached. It is a pending order that is automatically converted and executed as a market order once the last trade price on the market reaches the stop price. By default, stop-loss orders are Immediate or Cancel (IOC), but depending on the needs of the trader, they can also be set as Fill or Kill (FOK) orders.
In a fast-moving market, you may want to make precise market movements at specific moments. How does a stop-loss order work? Take the example of a stop-loss order set just below a critical support level. If the price tumbles and falls below that point, there is likely to be more downside pressure as the bears ramp up, selling their positions. Once the asset’s price falls and reaches the price at which the stop-loss order is set, the position will close automatically, limiting further uncontrollable losses.
In the management of an active portfolio, a specific asset can carry great promise and unmitigated risk. Investors often seek to maximize the former while managing the latter. That is where stop-loss orders come in handy as one of the many tools traders can deploy in their risk management.
If you are contemplating how to start trading, why should you use stop-loss orders? Well, stop-loss orders are integral to trading and are recommended even by experienced trading gurus. Their function is to ensure that you buy or sell a security at a specific price, sharing in the potential prosperity but giving you a necessary shield just in case your price prediction is wrong. Note, though, that stop-loss orders do not guarantee that you will have a profitable portfolio. You still have to make intelligent market decisions to experience great earnings. It is only a risk management tool and works more as a defense mechanism.
Below are the pros and cons of using stop-loss orders:
1. When using a stop-loss, you don’t have to monitor how an asset is performing all the time.
2. Stop-loss orders take emotions out of decision-making. In ordinary trading, you may fall in love with a stock and hold onto it for too long. A stop-loss sell order allows you to dispose of an asset when losses are no longer manageable.
3. A stop-loss costs nothing to implement. Commissions come about only once the stop-loss price has been reached and the stock must be sold.
4. The general purpose of a stop-loss order, as the phrase suggests, to stop losses. Alternatively, they can lock profits when they are stop-loss buy orders. A stop-loss is a simple and effective tool for nearly every investment style.
- Short-term fluctuation in an asset’s price may activate a stop-loss order even despite not triggering sustained losses.
- In a fast-moving market, the spot price at which an order gets filled may be different from the stop-loss price. An example is crypto assets, where the news can move prices quite fast. This discrepancy is called slippage.
How to Place Stop-Loss Orders
In terms of how to place a stop-loss order, it is important to appreciate the basics of trading. Traders must be cognizant of broad trading terminology to make meaningful use of stop-loss orders.
To make use of a stop-loss order when trading, you have to have an asset in the market and use an exchange that supports this advanced order type. An example of such an asset in crypto trading is Bitcoin or USDT.
Let’s use Bitcoin as an example of a stop-loss order.
Suppose you want to trade the BTCUSDT pair on Xena Exchange at spot rates. You are convinced that the value of BTC, the underlying asset, will rise if the US SEC approves the first Bitcoin ETF in December 2019. However, you are not too sure and therefore need insurance just in case your call is wrong and prices tumble. Therefore, you buy at spot rates but simultaneously place a stop-loss order of 3 percent.
Weeks later, the SEC disappoints the market and fails to approve the derivatives product, causing the fragile BTC market to tumble, dragging prices down 30 percent for the day. Thanks to the stop-loss order in place, your losses are limited to 3% and not 30%, as they would have been if you had traded without a stop loss.
Some scenarios limit the usefulness of stop-loss orders. In very volatile markets, price swings can be so fast that stop-loss tools end up being counterproductive, especially when prices gap up or down. Therefore, just because you can use a stop-loss order doesn’t mean you should always do so. Having an understanding of how an asset market works is fundamental to its effectiveness.
Types of Stop-Loss Orders
There are two types of stop-loss orders:
- Stop-loss sell order
- Stop-loss buy order
A stop-loss sell order is a type of stop-loss order that protects long positions by closing a market sell order if the price goes below a certain level. The assumption behind a stop-loss sell order is that if the price has fallen that far, it may continue to fall much further. A sell stop-loss caps the loss at that level. You get to sell the asset you are holding at the stop-loss price to prevent the possibility of further losses.
On the other hand, a stop-loss buy order allows traders to protect short positions. It is conceptually similar to stop-loss sell orders but works in the opposite way. A stop-loss buy order automatically comes into effect once prices get above a certain mark. It is ideally placed above the last market price and fires when the last trade price becomes greater than or equal to the stop price of the order.
Stop-loss orders are available on Xena Exchange. Investors can use this tool to conveniently trade and manage assets in the market. Alternatively, traders can use take-profit orders to close out positions to ensure near-maximum profits. For instance, investors can use a take-profit order for long positions and place the order slightly below or at key resistance levels.
Traders can also utilize other special stop-loss order types on Xena Exchange, such as trailing stop and attempt zero loss orders. These stop-loss orders allow investors to automatically cut their losses in the market.
Let’s look at what they entail in detail:
Trailing Stop-Loss Order
A trailing stop-loss (TSL) order is similar to a stop-loss in certain ways. The difference is that unlike a stop-loss, which is static, trailing stop-loss orders follow the price as it moves up and wait if the price moves down.
If you use this type of order, the stop-loss price will change to maintain a constant distance from the current market price. Trailing stop-loss orders allow traders to minimize risk when the price moves in the direction of the forecast they have made. If the price starts falling, trailing stop-loss orders don’t move.
Investors can set the distance at which a TSL follows the price as a percentage when entering the market. Take a hypothetical Bitcoin price of $10,000 with a TSL of 10%. The TSL would start at $9,000 and follow the price at a maximum deviation of 10%. If the price moves up in your favor, the TSL also moves up, retaining the deviation you set. This means that the stop-loss moves up instead of remaining static, like a conventional stop-loss. If the price moves against your interest, the TSL does not move.
Trailing stop-loss orders are a tactical tool. They work excellently in a market like the Bitcoin rally of December 2017. A TSL of 10% would allow investors to move up their stop-loss for Bitcoin, which had gone up with the rally. When Bitcoin began to decline in January 2018, the TSL would close out their positions and lock in profits. In this way, trailing stop-loss orders offer better flexibility for investors in tracking assets. In a rallying market, they can be your best ally.
Unlike on many other trading platforms, at Xena Exchange, trailing stop-loss orders are handled on the server side, which means you do not have to keep your trading terminal working all the time. Because this function requires certain resources on our servers, the number of active trailing stop-loss orders (including attempt zero-loss orders) is limited to three per client and one per trading instrument.
Attempt Zero Loss
Attempt zero-loss orders are trailing stop-loss orders that don't move beyond the position’s opening price.
Stop-Loss vs. Stop-Limit Order
Different types of orders are available for traders to use. For investors looking at when to fix profits and losses in trading, these orders represent useful tools. Stop-loss orders close out your position when it falls to a certain. On the other hand, stop-limit orders determine a “limit price” and do not execute until the price reaches that level. By default, stop-limit orders operate as Good till Canceled (GTC) orders.
A limit order is a request to buy or sell an asset at a specified price. The order may get filled at a better price, but the price limit is a prerequisite. Without it, the limit order will remain in the order book until another market participant hits it or it gets canceled.
Stop-loss orders have the guarantee of execution. In the process of an order hitting the field, the market price may have fallen lower than the stop-loss price. Such slippage is common in a fast-moving market. However, a limit order has a specific limit price, and the order only gets filled at the limit price or a better price.
Traders looking for precise execution can use stop-limit order rather than stop-loss orders. These kinds of orders guarantee a limit price. However, these orders incur the possibility of not being filled at all because of their rigidity. Stop-limit orders have the intent of locking prices at the desired level, whereas stop-loss orders limit losses or, in the case of trailing stops, ensure that you keep the profits you have made.
Choosing what type of order to use requires an understanding of how the underlying asset operates. Whether market makers see stop-loss orders or stop-limit orders as more preferable depends on their unique circumstances.
Technical analysis is crucial in understanding which order type to use and where to place them. Trading is a journey, and all the steps in this journey are important. Stop-loss orders are a useful tool for managing the risks that come with cryptocurrency spot trading. With consistent learning, traders can use these tools to ensure they maximize the potential of their portfolios.
Trade with Stop-Loss Orders on Xena Exchange
Xena Exchange is the ultimate crypto marketplace to apply your knowledge of stop-loss orders. With a range of derivative contracts on offer, you can build a dynamic investor portfolio on Xena Exchange. Stop-loss orders allow investors to trade while managing the losses that are natural in trading.
Spot trading is easy and efficient on Xena Exchange. With the various order types available on the platform, you can optimize your crypto portfolio effectively. Stop-loss orders will be useful once you learn the ropes of trading, which the Xena Exchange blog can help you out with.