Stop Loss Orders – Strategy & Techniques

Stop Loss Order

Learning when to enter a trade is just one step of becoming a successful trader. It’s just as important that you have a plan on where you will exit your trade when things go wrong. For this we use a stop loss order.

What Is A ‘Stop Loss Order’

A stop loss order is a trade placed with your broker to sell a security when it hits a defined price. Stop loss orders help to to limit you potential losses when a trade goes against you.

When you are long a position a stop loss order will execute a sell order when price drops to your stop price taking you out of the position. If you are short a security a stop loss order would trigger a buy order at the defined price.

It’s important to note that price is not guaranteed when using a stop loss order. It’s actually quite common to be filled at a worse price than you’re defined stop loss price due to liquidity.

Trading Without A Stop Loss

Hopefully you thought this heading was crazy when you read it…because it is. Trading without a stop loss is the ultimate recipe for disaster.

Anyone who makes an argument for not using a stop loss order is most likely not a very successful trader. Some will argue that fear causes them to place their stops too tight so they don’t use them. That may work for a while… Up until they enter into a position that moves drastically against them due to news or illiquidity and they will end up getting crushed on one trade as they constantly look for a bounce to get out of their position.

When you’re trading the only time you have complete objectivity is prior to entering a trade. Once you are in the trade you begin to lose your objectivity due to emotions. This is why it’s imperative that you not only use a stop loss but determine your stop price prior to entering a trade.

I can still hear Art, the founder of GPC, walking around the trade floor and asking traders stuck in losing positions where their out was. Time and time again these traders would be like a deer caught in the headlights, without an answer…simply hoping.

Stop Loss Order Types

There are two types of stop loss orders, stop orders and stop-limit orders. Let’s take a look at the difference in the order types.

Stop Orders

Sell-stop orders protect your position by triggering a market order to sell if you’re long when price falls below a defined level. A buy-stop order would protect a short position by triggering a market order to buy if prices rise to a defined level.

When placing a stop order your execution is guaranteed but price is not.

For example, assume Joe is long 1000 shares of ABC stock at $50 per share. He wants to exit the trade if price falls to $45 so he places a sell-stop order at $45. Price declines and hits the $45 level at which point his market order would be triggered to sell 1000 shares. Joe might get filled 500 shares at $45 and the remaining 500 shares at $44.50.

Where you will be filled depends on the time you placed the order, the liquidity of the security, and your position size.

Stop-Limit Orders

Similar to a stop order, the purpose of a stop-limit order is to minimize losses but as the name states there is a limit at which your order will be filled. Stop-limit orders guarantee price but not execution.

There are two prices defined when using a stop-limit order. The stop price is the price at which the order will be triggered and the limit price is the price that the order will be filled at or better. Obviously there is no guarantee this order will be filled especially in highly volatile or illiquid markets.

For example, lets assume Joe is short 1000 shares of XYZ stocks at $30 per share. He places a buy stop-limit order at $35 with a limit price of $35.50 to exit him from the position. XYZ begins moving up against him and hits $35 per share at which point his limit order to buy at $35.50 is triggered. The risk Joe is taking is that if the market is illiquid and moves above $35.50 before he is filled he won’t be filled until the price drops back down below $35.50.

Which Order Type to Use

As a day trader I only use stop orders. Yes I may be filled at a worst price, but I’m always looking to limit my risk. I place my stop orders at prices that prove to me my position is wrong. I’m not in the game of hoping so I’d prefer to exit the position no matter what the price.

Stop-limit orders are typically used by long term investors who are actively monitoring the market. News releases may drastically move a security that fundamentally they believe in holding long term.

Stop Loss Strategies

Lets review some of the most popular stop loss strategies. Implement any of theses techniques to help mitigate your trading losses.

Fixed Stop Order

My least favorite of all stop loss strategies. A standard stop order is always set at a fixed price and doesn’t take into account account market volatility nor does it move during the trade. Either your take profit is hit or you will be stopped out at your intial stop price.

For example, you decide to go long Facebook (FB) at 130.20 with a 15 cent stop loss.


As you can see your stop would be at $130.05 and is fixed there throughout the trade. Either you hit your take profit or you will be stopped out for a 15 cent loss at $130.05.

Fixed Trailing Stop

A fixed trailing stop will automatically move your stop loss by a fixed amount that you define as a trade moves in your favor. Your position must move a certain amount of ticks/pips/points defined by you in order for the stop to move.

For example, you go short Facebook (FB) at 117.30 with an initial stop of 20 cents with a fixed step of 10 cents.

Fixed Trailing Stop

When price declines and hits $117.20 (10 cent decline) your stop would automatically move down 10 cents to $117.40. As seen above, your stop would continue to move down by 10 cents for every 10 cents FB declines in your favor until your stop was hit closing on your position. You would have been stopped out on this trade at $117.00

Dynamic Trailing Stop

Similar to a fixed trailing stop, a dynamic trailing stop automatically moves your stop as your position goes in your favor. However, with a dynamic stop your stop loss will move for every tick/pip/point that the market moves in your favor.

For example, once again you decide to short Facebook (FB) at $117.30 with an initial stop at $117.50.

Dynamic Trailing Stop

As seen on the chart above, your stop loss begins to move down by 1 cent for every cent Facebook moves in your favor until your stop is hit. This trade hit a low of $116.72 which moved our stop down to $116.92 at which point the market bounced and took you out of the trade.

Swing Highs & Lows

This is personally my favorite stop loss management strategy. Market volatility changes and using swing highs and lows to manage your stops allows you to appropriately react to that volatility.

Swing highs are the peaks reached on a security when the high of a price is greater than surrounding price action. A new swing high is made when price breaks down to new lows. When a security is making Lower Highs and Lower Lows the security is in a downtrend.

Below are some examples of swing highs.

Swing Highs

Swing lows are the troughs reached on a security when the price is lower than a given number of lows positioned around it. A new swing low is made when price breaks out to new highs.

When a security is making Higher Highs and Higher Lows the security is in a uptrend.

Below are some examples of swing lows.


In the image below you can see how you would use the swing low for your stop loss when going long and the swing hight for your stop when going short.

Swing Lows

You can also move your stop loss similar to a trailing stop when a new swing high or low is created as seen on the chart below.

Swing High/Low Trailing Stop

You entered short once again at $117.30 with your initial stop above the swing high. As new swing highs are created you manually continue to move your stop loss order above the swing high until a swing high is hit. On this trade you would of been taken out on the break of the third swing high at $116.73.

Moving Averages

Using moving averages are another great way to manually trail your stop loss.

Moving Average Trailing Stop

Once again you go short Facebook at $117.30. You manually trail your stop below the moving average (blue line) until price breaks above. On this trade price broke above the moving average at $116.91 taking you out of your position.

Stop Loss Tips

  • Have an out…and USE IT!
  • Always make sure your stop loss was filled. Don’t just assume.
  • Determine your stop loss prior to entering a trade while you still have complete objectivity.
  • Never move your stop once in a trade unless you’re moving it in your favor.
  • Remember that stop orders guarantee execution where as stop-limit orders guarantee price.
  • Use trailing stop orders to remove emotions from a trade helping you stay in trending trades longer.
  • Remember when trading illiquid securities you may want to use a stop-limit order to prevent bad executions. An even better option is to stay away from illiquid securities 🙂

As traders we are constantly trying to gain an edge over the rest of the market. Properly mitigating your losses helps put you one step closer to having that edge.

Now that you’re a stop loss guru try some of these strategies with your current trading strategy. Let me know how they work for you!

Share this:

Leave a Comment

Your email address will not be published. Required fields are marked *