Different Types of Stop Loss Orders Explained

If you ask a seasoned trader what method they used to prevent blowing up their account, they will most likely give you the same answer: a stop loss. Stop loss orders are the security blanket on trading. While a stop does not promise profit or returns, it does prevent a small loss from becoming a catastrophic loss.

What failure to realize for many new traders is that there is not just one kind stop loss order. There are two different styles that each serve a different purpose in relation to your trading style and the kind of market you are trading, which is something to think about.

What is a stop loss?  

A stop loss is a pre-set order to close your position once the market hits a certain price. The goal of a stop loss is to limit or cap your loss in order to protect your capital. Without a stop loss, your emotions take over and traders usually remain in positions far longer than they should.

Think of a stop loss as being similar to a fire alarm for your house. You hope and pray you never have to use it, but it will definitely save you from a major loss if something goes wrong with your home.   

1. Fixed (Standard) Stop Loss  

A fixed stop loss is the most basic stop loss of stop losses. As a trader, it is a fix level that you set when you enter the market. If the market hits the fix level, then you trade will close automatically.  

For instance, if you bought the EUR/USD at 1.1000 and set a stop loss at 1.0950, then you limited your maximum loss of that trade to 50 pips.

This method is suitable for traders that mostly desire an uncomplicated process and clear levels. The downside of this approach is that it may be easy to get stopped out in volatile conditions, even when the trend resumes.

2. Trailing Stop Loss

A trailing stop is similar to a stop loss (trailing behind) but it will move with the market in your favor. You don't need to set a trailing stop at a fixed distance every time—your trailing stop increases automatically in distance after your position moves into profit, while still giving flexibility for the trade to go further.

For example, let’s say you set a trailing stop 30 pips away from the market price. If the market increases 50 pips, the stop loss can increase to trail backward, securing at least 20 pips in profit if the market reverses. 

Think of it like a safety rope climbing with you as you climb a mountain, securing you as you achieve new heights.

3. Stop Loss Based on Volatility

Some traders prefer to develop stops based on the volatility of the market instead of a fixed number. They will seek additional tools like the Average True Range (ATR) to gauge a safe distance for a stop.

In the calmer market conditions, the stop might be tighter but in a volatile market, you give more scope to avoid being shaken out. The volatility approach = flexibility, and that could save you from getting "noise" stopped out from small fluctuations through less favorable market conditions.

4. Guaranteed Stop Loss

Not all brokers will offer a guaranteed stop loss, but it is a great option when they do offer it.A guaranteed stop loss makes sure that your trade closes at the exact price that you set. There is no slippage and no surprises here.

This is especially helpful in times of high-impact news when the price can gap. The only downside is that your broker will charge you more for that protection.

A mental stop loss

Some traders use what is referred to as a mental stop loss. They are not placing it in the system. They are set that they will quickly check back to close the trade.

While this seems flexible, it can be catastrophic as emotions often supersede discipline and many traders tend to carry losing trades much longer than intended. A mental stop requires a lot of self-disciplines which not everyone possesses.

Comparing the types

Here is a simple comparison:

Which is best

There is not one clear cut best stop loss. It depends on your trading style. If you like structure, a fixed stop is neat and reliable. A trailing stop and volatility stop requires flexibility. If you trade around big news a guaranteed stop loss may be worth your costs.

Most importantly always put some risk measure in. No strategy wins all of the time. Stop losses are your insurance policy to be able to trade another day.

Conclusion

Stop losses aren't the most glamorous part of trading, but they are certainly among the most important. Fixed stop losses, trailing stop losses, and volatility based stop losses all provide some form of protection to mitigate risk and protect your capital.

Best traders know that it isn't about taking loss all together, it about controlling the losses. If you are interested in learning more about mechanically setting stop losses in your trading strategies head over to the Learn section on Wikilix. This is where you can find step-by-step guides to practice this and make it a habit.