Stop-loss orders

What a stop does

A stop-loss is an instruction to the broker: if the price reaches this level, close the position at the market. On a long position the stop sits below the entry price; on a short it sits above. When the level trades, the stop becomes a market order and is filled at the next available price. The point is to fix the maximum loss on the trade before it is placed, which is what the position sizing method depends on.

Stops can be moved. A trailing stop follows the price at a set distance as it moves in your favour and stays put when it moves against you, which locks in some of a gain without the trader having to act. Moving a stop further away to avoid being stopped out is the opposite habit and the one that turns a small planned loss into a large unplanned one.

Why a stop is not a guarantee

A stop triggers at its level but fills at the next price the broker can deal at, and in a fast market that can be some way past the level. This is slippage, and it is most severe when the market gaps: over a weekend, at a news release, or in a shock like the Swiss franc move of 2015, when stops set a few pips below the market were filled hundreds or thousands of pips away. A stop limits the loss under normal conditions; it does not cap it.

Some brokers offer guaranteed stop-loss orders, which are filled at the stated level whatever the market does, in exchange for a premium charged when the order is placed or triggered. Under the European and Australian rules retail clients have negative balance protection, which caps the loss at the account balance even if a stop is not honoured, and offshore brokers may or may not offer the same.

Where to place it

A stop belongs at the price where the reason for the trade is no longer valid: below the level the chart says should hold if the trade is right, or at a distance that reflects the instrument's normal movement. Placing it at a round number of pips or at the tightest distance the account can bear puts it inside the market's noise, where it will be hit by ordinary movement rather than by the trade being wrong. The position size should then be fitted to the stop, not the other way around.

Stops and the broker

Retail traders sometimes suspect brokers of running stops, meaning pushing the price briefly to trigger them. A broker that is the counterparty to the trade has the incentive, and regulators have fined brokers for manipulating quotes, but the far more common explanation for a stop filled at a bad price is a thin market and a wide spread at the moment it triggered. Comparing the broker's price with an independent chart at the time of the fill usually settles it, and a broker's execution statistics, where published, show how its stops fill on average.