In this lesson, we’ll take a look at how you can use both stop-loss and stop-entry orders to add discipline to your trading – minimising your risk, aiding planning and locking in running profits.
Using a stop-loss
Before opening a position, think about the maximum you’re prepared to lose on that trade. Remember, if you want a healthy risk-to-reward ratio, you need to control the amount of risk on each trade – which you can do by setting a stop-loss (a ‘normal’ stop in our platform).
As a guide, many traders wouldn’t risk more than 1% of their account equity on a single trade. By doing this, you’ll still have at least 99% of your account equity if the trade doesn’t go your way.
It’s important to note that the 1% rule applies to the total amount you’re willing to lose. This means if you have £10,000 in your trading account in cash or open positions, you’d cap your total loss on a single trade at £100 rather than buying £100 worth of CFDs, for example.
Once you’ve determined what percentage of your capital you’re comfortable risking, you can figure out where to put your stop.
Example
Imagine you want to open a long position on ABC plc, priced at 983 for £20 per point.
You have a total of £50,000 in your trading account, which is reflected in the ‘equity’ tab of the balance bar at the top of the platform.
You only want to risk 1%, so £500, of this equity. At £20 a point, this means you’ll need to close your position if the market moves more than 25 points against you.
By adding a stop-loss at 958 – 25 points below the current market price – you know that your position will automatically close out if the market reaches your risk threshold.
You can see both your stop-loss level and the amount you’ll lose just below the box where you enter your stop.
Let's face it, no one likes to lose. Seeing a trade you’ve placed losing money can tempt you to keep your position open longer in the hope that the market will bounce back.
But this can completely throw off your strategy and worsen your losses. The markets are unpredictable – no amount of research or analysis can exactly pinpoint the future price direction of an asset.
That’s why it’s so important to commit to a stop once you’ve placed it. A common mistake traders make is to set a stop only to keep moving it further away from the current market price to prevent the trade being stopped out. This can eventually lead to higher losses than planned.
Another thing to carefully consider is where to place your exit level. Setting a stop too close to your opening price could mean your trade gets closed out from normal market movements. If this happens, you’d lose your capital, the spread you paid to open the trade and any potential profits you could’ve made if the market bounced back in your favour.
If using the 1% rule places your stop level too close to your opening price, you should really consider if you can afford to take on higher risk. It could be worth looking for smaller contracts.
Guaranteeing your stops
With all orders there’s a risk of slippage. During times of volatility, it might not be possible to fill a basic stop-loss at the exact amount you set.
You can remove this risk by using a guaranteed stop, which is free to set. You’ll only pay a small premium if it gets triggered. You can set these in the deal ticket. Just select ‘guaranteed’ from the ‘stop’ drop-down as shown below.
Using a stop-loss to lock in profit
Stop-loss orders aren’t just for protecting against risk – you can also use trailing stops to lock in your profits at the same time.
These automatically adjust your stop level to a market’s movement, meaning they follow your position if the market moves in your favour. So in the end, when your trade is closed out, you’ll still have locked in some profits.
You can choose a trailing stop in the deal ticket – just select ‘trailing’ from the ‘stop’ dropdown.
Example
Say you open a long position on the FTSE 100 at 6255. You set a trailing stop at 6245 – ten points away from the current market price, and you also set a ‘trailing step’ at a distance of five points. The step is how far the market needs to move to activate your trailing stop.
The FTSE 100 moves by five points to 6260, the trailing step is triggered and your stop starts to follow the market price – maintaining the ten-point distance.
If the FTSE 100 were then to rise to a high of 6271, your trailing step would’ve climbed to 6270 and your stop would be ten points below that at 6260.
If the market fell by 40 points, your trailing stop would’ve fixed at 6260 and your position would be closed out, earning you a five-point profit you would’ve missed out on with a normal stop-loss.
As your stop moves closer (or even past) the opening price, your risk-to-reward ratio improves.
Remember that trailing stops aren’t guaranteed, so they can be subject to slippage.
If you’re watching a position and the market is moving in your favour, you can also lock in profit by manually moving a basic or guaranteed stop to follow the market. You can do this by editing your stop in the ‘positions’ panel:
Or by manually dragging your stop level on a market’s chart:
Remember, while it’s ok to move a stop closer to a market that’s moving in your favour, it’s not good practice to move a stop away from a market that’s moving against you.
Using stops to open
You can also use stops to open positions – we call these stop-entry orders. They’re a good tool when you want to take advantage of a market trend.
You can set them in the ‘order’ tab of the deal ticket. You’ll know that you’re setting a stop-entry because when you've filled your stop order level, the platform will automatically update the order button to a stop.
Example
XYZ Ltd is currently trading at 498.50. Based on your analysis, you’re confident that if the price hits 500, it will continue to rise. So you set a stop-entry order to open a long position at 500, which is 1.50 points above the current market level.
While you’ll pay a higher price than the current one, this is a good strategy to use when you want enter a market only if it behaves how you expect it to – if it appreciates, in this case.
XYZ Ltd does hit 500 and continues to rise. Your stop-entry order opens your position at 500 and you profit from the upward market movement.
Remember, the market can still move against you and there’s no guarantee that you’ll make a profit on your trade.
Stop-entry orders can help you avoid acting impulsively on market movement.
Lesson summary
- Work out where to place your stop by defining your risk threshold before you enter the trade
- Don’t be tempted to move a stop-loss once you’ve set it, even if the market moves against you
- Set trailing stops to lock in profit, and guaranteed stops to prevent slippage
- Use stop-entry orders to enter a trade when a market trend has been confirmed
