A stop loss order is a risk management tool used to limit potential losses on a trade. You set a specific price level below the current market price for long positions, or above it for short positions. If the asset reaches this predetermined price, the order automatically triggers a market order to close the position.
For example, if you purchase a stock at $100 and set a stop loss at $90, the order executes if the price drops to $90. This protects your capital by preventing further losses if the trade moves against your analysis. It removes the need for constant monitoring of the market.
While stop loss orders provide protection, they do not guarantee execution at the exact stop price. During periods of high volatility or market gaps, the asset price may move past your stop level before the order executes. This is known as slippage. Traders often use stop losses alongside position sizing to manage overall portfolio risk. Trading involves significant risk, and stop losses are only one component of a broader strategy to preserve capital. Always verify exchange policies regarding order types before trading.
How this answer was produced
AI-assisted draft, human-reviewed by AlphaScala editorial against our standards before publication. General education, not advice for your specific situation.