What is a stop-loss?
A stop-loss is an instruction to exit a trade when price reaches a chosen level. For a long position, the stop-loss is generally placed below the entry price. For a short position, it is generally placed above the entry price.
The stop-loss should be chosen before entering the trade rather than moved randomly after the market starts moving.
Logical stop-loss placement
A stop-loss should be placed at a level where the original trade idea is no longer valid. Depending on the strategy, this may be beyond a support or resistance level, outside a chart pattern, or at a distance based on market volatility.
- Beyond a recent swing low or swing high.
- Outside a support or resistance zone.
- Beyond a chart pattern invalidation level.
- At a volatility-adjusted distance.
Stop-loss limitations
During fast markets, news events, low liquidity, or price gaps, the actual execution price may differ from the stop price. This difference is commonly called slippage.
A stop-loss can reduce risk, but it cannot remove market risk completely.
Moving a stop-loss
Moving a stop-loss to reduce risk or protect an existing profit can be part of a defined strategy. However, moving it farther away simply to avoid accepting a loss can increase the original risk.