Using Stop Orders: What Are Stop Orders in Trading?

Stop orders are a complex and important facet of CFD trading, and may become an integral part of your trading strategy as you dive into this volatile market:

What Is a Stop Order?

A stop order, a fundamental order type in trading alongside market and limit orders, executes based on the direction of price movement. When the market declines, a sell stop order triggers at a preset price below the current market value. Conversely, during upward price movement, a buy stop order activates once the security hits a predetermined price above the market rate.

Several variations of stop orders exist, tailored to different trading positions and market strategies. At Plus500, we offer four different types of stop orders, and below we will delve into how they work and when they may be relevant to your trading decisions.

How Do Stop Orders Work?

When a trader submits a stop order in CFD trading, it enters the system and awaits specific conditions: triggering, expiration, or cancellation. Once activated, it becomes a market order, potentially leading to execution. However, the execution price isn't guaranteed, necessitating strategic consideration.

Stop orders in CFD trading serve vital roles. They can automatically trigger entry or exit based on price movements, often employed to safeguard profits or mitigate losses. A sell stop order prompts a sale at the next available bid price if the market price falls to or below the stop price. Conversely, a buy stop order, typically used as an exit strategy, triggers a purchase at the next ask price once the market price rises to or surpasses the stop price.

Traders must carefully time their use of stop orders, considering market conditions. These orders operate solely during standard market hours and don't execute during extended hours or trading halts. Such considerations are crucial for effective risk management and trade execution in CFD trading.

Stop Order Types

Stop orders have several subtypes, and it’s crucial to understand their nature and uses in order to best integrate them into your personal trading strategy:

Stop-Loss Order

In CFD trading, a stop-loss order functions as a protective mechanism for traders, allowing them to preset a specific price level at which their position will automatically close if the market moves unfavourably. This feature is invaluable for minimising potential losses and managing risk exposure. When the predetermined stop-loss price is reached or surpassed, the stop order is triggered, resulting in the automatic closure of the trader's position. However, it's crucial to note that while stop-loss orders are free of charge, there is no absolute guarantee that the position will close at the exact specified price level due to slippage.

Slippage, a common phenomenon in volatile markets, occurs when the actual execution price deviates from the intended price. This can happen when the market experiences rapid price movements or 'gaps,' causing the position to be closed at the next available price rather than the designated stop-loss level. Despite this inherent risk of slippage, stop-loss orders remain an essential tool for CFD traders seeking to mitigate potential losses and maintain disciplined risk management strategies in the dynamic and unpredictable world of financial markets.

Stop Limit Order

In CFD trading, a stop-limit order serves as a strategic tool enabling traders to protect their profits by setting a predetermined rate at which their position will automatically close. This feature is particularly valuable in volatile markets, where sudden price fluctuations can erode gains. When the specified rate is met or exceeded, the stop-limit order triggers the automatic closure of the position, effectively locking in profits and minimising the risk of loss. However, it's essential to recognize that while this feature is offered free of charge, there is no absolute assurance that the position will close precisely at the specified price level.

The distinction of a stop-limit order lies in its dual functionality: it combines elements of both stop orders and limit orders. By setting a stop price to trigger the order and a limit price to specify the desired execution price, traders gain greater control over their trades. This allows for precise management of profit-taking strategies while mitigating the potential impact of market volatility. Despite the absence of a guarantee regarding execution price, the stop-limit order empowers traders to proactively safeguard their profits and exercise disciplined risk management practices in CFD trading.

Trailing Stop Order

A trailing stop order is a dynamic risk management tool designed to protect profits while allowing for potential further gains. Unlike traditional stop orders, which are static and remain at a fixed price level, trailing stop orders adjust automatically as the market price moves in the trader's favour. This means that the stop price "trails" the market price by a specified distance, known as the trailing stop distance, ensuring that the position remains open as long as the price continues to move favourably. However, if the market reverses direction by the designated number of pips, the trailing stop order is triggered, closing the trade and locking in profits.

The versatility of trailing stop orders extends to both buy and sell positions, offering traders the flexibility to protect profits and limit losses in various market conditions. For buy positions, the trailing stop order serves to safeguard gains as the instrument's price ascends, while also mitigating potential losses if the price undergoes a downward reversal. Conversely, for sell positions, the trailing stop order protects profits as the price declines, while also minimising losses if the price experiences an unexpected upturn. While this feature is provided at no additional cost, traders should be mindful that execution at the specified price level is not guaranteed, underscoring the importance of monitoring positions and adjusting trailing stop parameters as market conditions evolve.

Guaranteed Stop Order

A guaranteed stop order serves as a safeguard against unexpected market volatility, ensuring that your position closes at your specified rate even if the market price surpasses it. This feature is especially valuable during turbulent market conditions when standard stop-loss orders may not be carried out at the desired price. Once the designated level is reached, the guaranteed stop order automatically triggers the closure of the position, providing traders with greater certainty and control over their trades. However, it's important to note that not all instruments support guaranteed stop orders, and traders should be aware that a fee, typically in the form of a wider spread, is charged for this added protection.

Several key characteristics distinguish guaranteed stop orders in CFD trading. They can only be applied to new positions and cannot be added to existing ones, ensuring consistent risk management practices from the outset of a trade. Additionally, guaranteed stop orders must be activated or edited during the instrument's trading hours, offering traders the opportunity to adapt their risk mitigation strategies in real time. Once placed, a guaranteed stop order cannot be revoked, although traders have the flexibility to adjust the specified level within certain minimum and maximum distances from the current market rate. While the wider spread incurred with a guaranteed stop order is non-refundable once activated, traders benefit from enhanced peace of mind knowing that their positions are protected against adverse market movements.

Stop Order Examples

Now let’s take a look at how using two different types of stop orders may take form when CFD trading:

Stop-Loss Order Example

Suppose you're trading CFDs on Tesla (TSLA), and the current buy/sell rates are $750/$748 per share. You decide to enter a CFD trade by opening a position on 20 shares of Tesla, but you're cautious about potential losses if the market turns against you. Therefore, you set a stop-loss order at $700 per share.

Unfortunately, the market sentiment suddenly shifts, causing Tesla's price to drop sharply from $748 to $680 per share. This movement triggers your stop-loss order. However, due to the rapid market volatility and slippage inherent in CFD trading, your position is closed at the next available price, which happens to be $680 per share.

Even though the stop-loss order was set at $700 to limit potential losses, the execution price deviated due to market conditions. Despite this, the use of the stop-loss order still proved beneficial in CFD trading by automatically closing the position as the price moved against you, thus minimising further potential losses.

Guaranteed Stop Order Example

Imagine you're trading CFDs on Apple (AAPL), and the current buy/sell rates are $200/$198 per share. You decide to enter a CFD trade by opening a position on 15 shares of Apple. Considering potential market volatility, you opt for a Guaranteed Stop Order with a wider spread of $15.

To protect against significant losses, you place a Guaranteed Stop Order at the sell rate of $180 per share.

Suddenly, Apple's sell rate experiences a sharp decline to $150 per share. However, due to the Guaranteed Stop Order, your position is closed at the specified level of $180 per share, safeguarding against further losses.

With the Guaranteed Stop Order: P&L = ($180 - $200) * 15 - $15 = loss of $315.

Without the Guaranteed Stop Order: P&L = ($150 - $200) * 15 = loss of $750.

In this scenario, the Guaranteed Stop Order effectively limited your potential loss compared to not using it, demonstrating its value in managing risk in CFD trading.

Benefits of Using Stop Orders

Stop orders are a fundamental tool in CFD trading, offering traders a strategic advantage in managing their positions and mitigating risks. While there are both advantages and disadvantages to using stop orders, their benefits often outweigh the drawbacks, providing traders with essential safeguards in dynamic market conditions.

Execution Guarantee: Stop orders ensure that trades execute at specified levels, even if traders are not actively monitoring market prices. This guarantees execution reliability and reduces the risk of missed opportunities or delayed actions.
Enhanced Control: By implementing stop orders, traders stand to gain additional control over their trading activities.
Loss Limitation: Stop orders serve as a proactive risk management tool, enabling traders to better limit potential losses.

Risks of Using Stop Orders

When engaging in CFD trading, risk is ever present, and the use of stop orders is no exception to this rule. Let’s look at some of the potential downsides to using stop orders:

Short-Term Fluctuation Risk: One notable drawback of stop orders is their susceptibility to short-term price fluctuations. For instance, if a stop order is placed with the expectation of continued price appreciation but the market suddenly shifts in the opposite direction, the position may incur losses due to being on the wrong side of the trend.
Slippage: An inherent risk associated with stop-loss orders is slippage, where the execution price may differ from the specified level. Factors such as market volatility, lack of liquidity, and price gaps in news or data can contribute to slippage. Consequently, traders may experience execution at slightly higher or lower prices than intended, impacting overall profitability.

How to Place Stop Orders With Plus500

Register your Plus500 CFD trading account and get verified
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Conduct technical and fundamental analysis on your chosen instruments
Discern which type of stop orders will best suit your trading strategy and plan how to implement them
Get to trading!

Conclusion

In conclusion, stop orders are integral to CFD trading, providing traders with essential tools to manage positions and mitigate risks effectively. However, as with all aspects of CFD trading, the benefits of stop orders must be weighed along with the significant risks. By understanding the nuances of different stop order types, traders may be well-placed to implement the usage of stop orders into their personal strategy and decisions in the CFD arena.

FAQs

What is the difference between a stop-loss order and a limit order?

A stop-loss order automatically closes a position at a specified price to limit losses, while a limit order sets a specific price at which to buy or sell an asset.

Where should I place my stop order?

Stop orders should be placed in accordance with your personal trading strategy and goals, considering support and resistance levels, market volatility, and individual risk tolerance.

Should I move my stop orders?

Moving stop orders should be done cautiously and based on market conditions, ensuring they are adjusted to protect profits or limit losses effectively.

What is a trailing stop order?

A trailing stop order adjusts with market movements, trailing the price at a set distance to protect profits and limit losses.

What is a guaranteed stop order?

A guaranteed stop order ensures that a position closes at a specified price, even if the market surpasses it, providing added protection against unexpected market volatility.

What is the best way to set up stop orders?

The best way to set up stop orders depends on the individual trader’s strategies, risk tolerance, and market conditions, and goals.