Let’s be honest: nobody likes losing money, but in markets it can happen faster than you think.
One minute you’re feeling like Warren Buffett, the next you’re staring at a red candle that looks more like a crime scene than a chart.
That’s where the stop loss order struts in, cape fluttering, ready to help limit losses when markets move against you. Think of it as the seatbelt of trading—not glamorous, sometimes uncomfortable, but an important tool for managing risk when markets get volatile.
In this guide, we’ll take a deep dive into stop loss orders, explaining what they are, how they work, and how you can use them effectively to protect both your capital and your sanity.
What is a stop loss order?
A stop loss order is an instruction you give a trading platform to close your position automatically if its price reaches a specified level (the “stop” price).
A stop loss order can be placed in both long and short positions.
How stop loss orders work
Stop loss orders work by monitoring the market price of your position and triggering a market order when the price hits your specified stop level.
Here’s how it typically works:
- Price setting: You choose a stop price at which you want the order to activate. It’s usually set below the current market price for a long position and above the current market price for a short position.
- Order placement: Once placed, the stop order sits quietly and does nothing until triggered. It’s not visible on the order book at that price; it’s a conditional order waiting for the trigger.
- Trigger activation: Once the trigger is activated, the stop loss order becomes a market order to sell i.e. close your position immediately. The trading platform will execute the sell at the best available price at that moment.
When and why to use a stop loss order
Stop loss orders are used to manage risk.
Here are some common reasons and scenarios for using stop loss orders:
- Limiting downsides: The primary purpose is to cap how much you can lose on a position.
- Protecting profits: Stop orders aren’t just for losses; they can also be used to exit a profitable position if the price moves against you, helping preserve some of your gains.
- Market monitoring: If you’re unable to watch your positions constantly, a stop loss order acts as an automatic exit plan. In other words, it’s like a “just in case” order that’s always working in the background for you.
- Removing emotions: Using stop losses enforces discipline. Once you set the order, you’ve pre-decided your max risk. This prevents the emotional trap of holding onto a losing trade, hoping it will rebound, or panic-selling too late.
- Risk management: If you’re trading on margin or using leverage, stop losses are especially critical. They help avoid catastrophic losses or margin calls.
That said, stop loss orders are not always necessary for everyone.
Long-term investors, for instance, might choose not to use stop losses on positions they believe in for the long run.
Risks of using stop loss orders
Stop loss orders are useful, but they’re not foolproof.
Be aware of these risks when using stop loss orders:
- Price gaps: Markets can sometimes jump from one price to another without trading at the levels in-between. If the price gaps past your stop level, your order will execute at the next available price, which could be much worse than you hoped.
- Volatile markets: In a choppy or volatile market, the price may dip just enough to trigger your stop and then quickly reverse back up in your favor. This means you sold at the low and missed the recovery.
- Setting stops (too tight): Placing your stop loss extremely close to your position price is a frequent mistake. Minor day-to-day swings can trigger a tight stop loss unnecessarily.
- Setting stops (too far): The opposite problem is picking a stop price that’s so far away that it’s nearly meaningless or choosing a round number without rationale.
- Obvious stops: Many traders tend to put stops right at obvious support or resistance levels. The issue is that countless other traders do this too. This creates a cluster of stop orders that savvy market participants are aware of. It’s not uncommon to see a price dip slightly below a popular support level—enough to trigger those stops—and then bounce.
- Emotional trading: One of the worst mistakes is not sticking to your stop loss. This typically happens in real time: the price is nearing your stop, and you panic or hesitate. Some traders will move the stop further away at the last second to “give the trade more room” because they can’t bear to take the loss. This defeats the entire purpose of a stop loss.
- Changing conditions: On the flip side, some traders forget to adjust stops when things change in a good way. Failing to do this means your original stop could let a winning trade turn into a loss or a smaller profit than you could have secured. Regularly revisit your stop placement, especially after significant price moves in your favor.
In short, stop loss orders require thoughtful placement. Use them as a shield against major losses, but set them wisely to avoid self-sabotage. Combine technical factors with your risk tolerance to decide where the stop goes. And once it’s set as part of your plan, try to honor it.
Stop loss order vs. buy stop order vs. stop limit order
It’s easy to get confused by these terms, so let’s break down the differences between a stop loss order, a buy stop order, and a stop limit order:
- Stop loss order: If the price reaches the stop level, it triggers a market sell. Mainly used for long positions.
- Buy stop order: If the price reaches the stop level, it triggers a market buy order. Mainly used for short positions.
- Stop limit order: A stop limit order adds an extra condition on the price. It also has a stop trigger price like the above orders, but when triggered, it becomes a limit order instead of a market order.
In essence, all three order types involve a stop trigger; the difference is what happens after the trigger (market execution vs. limit order) and whether you’re buying or selling. Knowing these differences helps you choose the right tool for your needs and avoids surprises when your order hits.
Stop loss trading with Phantom
Beyond spot trading, Phantom Perps enables eligible users in permitted jurisdictions to trade perpetual futures using stop loss orders.
Most perps platforms today are designed for pros with complex trading features, which can be challenging and potentially dangerous for inexperienced users. But with Phantom’s intuitive, mobile-first design, you can easily open, close, and manage positions directly within your wallet. Even so, the same underlying risks apply, regardless of the fact that Phantom Perps may feel more straightforward to use.
FAQs
Disclaimer: This content is for general educational purposes only. It is not financial advice, investment guidance, or a solicitation to buy, sell, or trade any assets, products, or services. Past performance is not indicative of future results. Any examples or strategies discussed are for illustrative purposes only and should not be considered as recommendations. Perpetual futures are complex, high-risk instruments that are not suitable for all investors. Phantom Perps are not available everywhere. This guide is not intended for UK audiences.
