A stop-loss order is a type of conditional order in financial trading that automatically closes a position when the asset reaches a specified price.

Purpose:

• To limit potential losses on a trade.
• To protect capital from significant decline.
• To manage risk and avoid catastrophic losses.

How Stop-Loss Orders Work:

1. Setting the Stop-Loss Price: The trader specifies the stop-loss price at a certain level below the entry price.
2. Triggering the Order: If the asset price reaches the stop-loss price, the order is executed, closing the position at that price.
3. Exit at Stop-Loss: The position is exited at the stop-loss price, regardless of whether the trader has manually placed an order to close it.

Types of Stop-Loss Orders:

• Market Stop: The order is executed at the best available price in the market at the time of triggering.
• Limit Stop: The order is executed at the specified stop-loss price if it becomes available in the market.
• Trailing Stop: The stop-loss price is moved along with the asset price when the asset moves in your favor.

Advantages:

• Provides a clear exit point in case of a loss.
• Limits potential losses.
• Can help manage risk.

Disadvantages:

• May not be able to get the best possible price if the market moves rapidly against you.
• Can be emotionally difficult to see your position closed against your will.
• May not be suitable for complex trading strategies.

Best Practices:

• Place stop-loss orders with enough buffer to account for market volatility.
• Use trailing stop-loss orders to lock in profits as they increase.
• Review stop-loss orders regularly to ensure they are still active.
• Consider the overall risk tolerance and objectives of your trading strategy when setting stop-loss prices.

Example:

You buy an asset for $100 and set a stop-loss order at $90. If the asset price drops to $90, your stop-loss order will close the position at that price, limiting your potential loss to $10.