What Is a Stop-Loss Order?
A stop-loss order is placed with the broker to sell the security when it reaches a certain price. These orders help investors minimize their losses in their securities positions. Therefore, if you set a stop-loss order 10% below the price you purchased the security, the loss is limited to 10%.
It is always recommended to use proper risk management, but it might lead to further losses instead of profits when used incorrectly. Common mistakes that traders make when setting stop is as follow:
Placing stops too tight.
The first common slipup is placing stops too tight. There won’t be enough breathing space for the price to vary before eventually heading your way by placing constricted stops on trades.
Always keep in mind to take into account the volatility and the fact that it could go up or down around your entry point for a while before continuing in a specific direction.
So, don’t forget to give your trade sufficient time and consider volatility.
Using position size
It is bad to use the position size instead of the technical analysis to determine the stop. Estimating the stop distance using the position size has nothing to do with market movements. Since we are trading the market, it makes much more sense to place the stops based on the market’s direction. Now that we have selected entry points and targets based on technical analysis, we need to do the same for stops. Don’t forget the position size completely, but before calculating the position size, you must first decide where to place the stop.
Placing stops too far or too wide.
Some traders mistake setting stops too wide and cross their fingers to move in that direction sooner or later. If the stop setting is too wide, the number of pips that the trade must move in favour of the work will increase for the business to be worth the risk. Some brokers offer bonuses such as trade245 bonuses.
The general rule of thumb is to place the stop closer to the entry than the profit target. If the risk-to-reward ratio is good, for example, 2: 1, you are more likely to make a profit if the transaction is correct with a probability of at least 50%.
Placing stops exactly on support or resistance levels.
When deciding where to place the stops, it is helpful to note the level of support and resistance nearby. If you’re going long, look for a nearby support level below your entry and stop in that area. If not enough, you can find the next resistance level above the threshold and stop there. But putting it directly at the support or resistance level is not a good idea. The reason is that even if the price reaches this level
you may still have the opportunity to turn around and head in your direction. Placing a few pips of stops outside this area will give you almost certain that your support or resistance is already broken, and you can admit that your trading idea was wrong.