Stop loss order explained simply

A stop loss order is a tool used to limit losses when trading. It helps investors execute a sell order automatically once a security reaches a pre-defined price. This order supplement protects against unexpected price drops and minimises risks without having to constantly monitor the market. In this guide, you'll learn what a stop loss order is, how it works and where best to place it. With practical examples and tips, you'll learn how to use this instrument optimally for your strategy.

• A stop loss order is a sell order that is executed automatically once a pre-set price is reached, in order to limit losses.

• It is suitable for shares, cryptocurrencies and other securities and helps avoid emotional decisions as well as continuous market monitoring.

• Risks such as slippage or unnecessary sales due to short-term price movements can be reduced with careful placement and dynamic variants like trailing stops.

• In the buy and hold strategy, a stop loss order can protect investments but should be used thoughtfully to benefit from long-term price increases.

What is a stop loss order?

A stop loss order is a sell order that is executed automatically once a security reaches a pre-set price. The goal of the order is to limit losses by selling a security before its price drops further. Investors use this method to protect their investments from major price declines without having to constantly monitor the market.

The stop loss order is often linked to a specific price limit, known as the stop loss threshold, and can be used on almost any trading venue. As soon as the security's price reaches or falls below this threshold, the order is triggered and executed as a market order. This helps reduce the risk of unexpected losses.

This type of order is suitable for various asset classes such as shares, cryptocurrencies or other exchange-traded instruments and is often used in combination with a buy order. Especially in volatile markets, the stop loss order is a tool to maintain oversight and control losses. In addition to limiting losses, it also helps avoid emotional decisions, which investors often make under pressure.

Similar order types

In addition to the classic stop loss order, there are other types of orders that help investors manage risk and adapt their trading strategies. These order supplements offer added flexibility to respond to different market situations, whether to minimise losses or secure profits. These similar order types operate through specific mechanisms based on dynamic adjustments, fixed limits or the combination of multiple orders. They're particularly suitable for investors who want to manage their positions effectively in both volatile and more stable markets.

Trailing stop loss order

The trailing stop loss order is an advanced version of the classic stop loss order and provides a dynamic adjustment of the stop price in line with the security's price movements. Unlike the standard stop loss order, the threshold isn't fixed but trails the price by a pre-defined distance when it rises. This allows investors to secure profits while still limiting losses. This flexibility makes the trailing stop loss order a good alternative for investors who want to benefit from rising prices without losing sight of risk.

Key features of a trailing stop loss order at a glance

• Dynamic adjustment: the stop price is automatically adjusted upwards when the security’s price rises but remains unchanged if the price falls

• Distance from price: investors set the distance (in percentages or fixed values) that the stop price should maintain from the current market price

• Automatic execution: once the price reaches the dynamically set threshold, the order is executed as a market order

• Profit protection and loss limitation: rising prices secure potential profits while a drop limits losses

• Flexible use: especially suitable in volatile markets to respond to quick price movements

Stop limit order

The stop limit order combines elements of the stop loss order with a limit, enabling investors to control both sell and buy orders more precisely. Unlike the classic stop loss order, the order is only executed if the price hits the defined stop threshold and also meets the specified limit. This type of order is particularly useful for retaining more control over the execution of sell orders, especially in volatile markets, to avoid unfavourable prices.

Key features of a stop limit order at a glance

• Stop threshold and limit: the order is triggered when the stop threshold is reached but only at a price that meets the set limit

• More control: investors can ensure their sell order isn't executed below a certain minimum price

• No market order risk: prevents a sell order being executed at an unfavourable market price

• Flexible configuration: both the stop threshold and limit can be tailored to market conditions and investor risk

• Use in volatile markets: particularly helpful for limiting losses without relying on fixed price execution

One cancels the other option (OCO)

The one cancels the other option (OCO) is an order type in which two separate orders are combined, with the execution of one order automatically cancelling the other. This method is often used to simultaneously set a target for taking profits and a limit for stopping losses. The benefit is that investors can cover both scenarios with a single combined order without having to constantly monitor the market.

Key features of the one cancels the other option (OCO) at a glance

• Combination of two orders: an OCO order typically consists of a stop loss order and a limit order used together

• Automatic cancellation: once one of the two orders is executed, the other is automatically cancelled to avoid conflicts

• Strategic flexibility: investors can define both a profit-taking level and a loss limit within a single order

• Efficient risk and profit management: helps minimise losses or secure gains, depending on which scenario occurs first

• Time-saving: no manual adjustment needed, as the orders react automatically based on price movement

What does a stop loss order cost?

Placing a stop loss order is usually free on most trading platforms. Investors don't pay any additional fees for setting up this order. However, the usual trading fees apply when the order is actually executed. These costs vary depending on the trading venue and broker.

In times of high market volatility, slippage can occur with stop loss orders, which investors should take into account. Slippage means the actual execution price may differ from the set threshold, as the order is executed at the next available market price if there are no offers at the desired price.

Where should traders place a stop loss order?

Before entering a position, it's important to define exactly where the stop loss should be set. The stop loss order should be placed immediately after opening the position to limit losses from the outset. The threshold should limit losses but not be triggered by small, normal price movements that can occur shortly after executing a buy order. A sensible approach is to set it below key support levels or at a distance adjusted to market volatility.

Key factors for placement

• volatility: in the case of strong price movements, the stop loss should be set further from the current price to absorb minor fluctuations

• support and resistance levels: a stop loss just below a key support zone provides protection, as these levels often act as price floors

• position size: the larger the position, the tighter the stop loss should be set to keep losses manageable

Margin trading and the use of stop loss orders

Margin trading allows you to trade with leverage – meaning you can take on a larger position than your available capital would normally allow. This can significantly amplify potential profits. At the same time, the risk of losses increases, as price movements have a greater impact on your invested capital.

Especially in margin trading, a well-thought-out risk management strategy is essential. A stop loss order is an especially valuable tool here. It protects you from uncontrolled losses by automatically closing your position once a pre-defined price is reached.

Stop loss orders therefore help you make targeted use of the high potential of margin trading without taking unnecessary risks. By placing this order correctly, you can ensure a quick reaction to unfavourable price developments and protect your capital.

Stop loss order – pros and cons

The stop loss order is a tool for limiting losses and maintaining control over your investments. However, this method also has its pros and cons, which should be considered depending on market conditions and strategy.

Advantages of a stop loss order

• Risk limitation: protects against larger losses by triggering an automatic sell order

• Emotion-free decisions: prevents impulsive actions since the sell order is set in advance

• Time-saving: doesn't require constant market monitoring as the order is executed automatically

• Flexible use: suitable for various markets such as shares, cryptocurrencies or other securities

Disadvantages of a stop loss order

• Slippage risk: in volatile markets, the actual execution price may differ from the set stop price

• Short-term triggers: small, temporary price dips can trigger the order even if the price later rises again

• Limited control: the order is executed at market price, which can fluctuate significantly depending on market conditions

Example: how to set a stop loss order correctly

Suppose an investor buys a share on the stock exchange at a price of €100 and wants to limit losses to a maximum of 10 percent. In this case, a stop loss order could be set at €90. If the share price falls to or below €90, the sell order is triggered automatically and the share is sold at the next available market price. This prevents further price declines from leading to greater losses.

This example shows how a stop loss order works and how it can help investors manage their risk effectively. By setting the sell order in advance, the order protects against unexpected price drops and minimises potential losses. At the same time, it ensures that the decision is based on clear criteria and not influenced by emotional reactions. Especially in volatile markets where prices can fall rapidly, the stop loss order enables a clear strategy that saves both time and stress. It's therefore particularly suitable for investors who want to keep their risk manageable without having to monitor the market continuously.

Stop loss in the buy and hold strategy

The stop loss order can also be used within the buy and hold strategy to protect long-term investments from significant losses. Although this strategy aims to hold securities over an extended period and benefit from long-term price increases, a stop loss order can help avoid heavy losses during sharp declines.

However, it's important to use stop loss orders cautiously in this context. Small, short-term price drops are usually part of normal market fluctuations and shouldn't trigger unnecessary sales. Investors with a long-term perspective should therefore set their stop loss threshold more generously to avoid being stopped out of their position by temporary movements.

A targeted use of the stop loss order can thus help reduce the risk of large losses while keeping the long-term goals of the buy and hold strategy in focus. This preserves the balance between capital protection and benefiting from long-term market opportunities.

Risk considerations with stop loss orders

While stop loss orders are an effective tool for limiting risk, there are also potential challenges investors should be aware of. The main risks include market gaps and high volatility, which can lead to the order being executed at an unfavourable price. In such situations, the actual sale value may fall well below the set stop threshold – this is known as slippage.

Another risk is that a stop loss order may be triggered by short-term price drops that have no lasting impact. As a result, an investor could be stopped out of a position even though the price later recovers.

To minimise these risks, investors can take the following steps:

• use trailing stops: a trailing stop loss order dynamically adjusts the threshold when the price rises, protecting both gains and against losses

• set stop prices carefully: the threshold should be adapted to market conditions and the security’s volatility to avoid triggering the order unnecessarily

• monitor market conditions: in especially volatile markets or ahead of major events (e.g. quarterly results), it may make sense to adjust or temporarily suspend the stop loss

More topics around trading

Want to learn more about how to trade precisely and efficiently using order supplements? The Bitpanda Academy offers not only detailed explanations of special order types like the stop loss order, but also comprehensive guides and tutorials on cryptocurrencies, share trading, blockchain technology and various trading strategies.