Stop loss is a trading tool designed to limit the maximum loss of a trade by automatically liquidating assets once the market price reaches a specified value. There are multiple types of stop loss that can be used in different scenarios depending on the crypto market situation. It can sometimes be difficult to avoid loss due to the many possible market outcomes, but stop loss can be helpful even for new and inexperienced traders.
When is it used?
Unlike a limit order, which aims to profit from the current trends, a cryptocurrency trader will use a stop loss order to limit potential losses to no more than they are able to take on.
This is not only a step towards maximizing profits, it also expands the trader’s options for strategizing, by increasing their control of the trade’s risk factor. For stop loss to be used effectively, the trader still needs to predict how the market will behave and tailor the stop loss accordingly—otherwise it may not only fail to prevent loss but also multiply it. Once the trader has an idea of how the market will behave, they must choose both the value and type of stop loss order they wish to use.
Stop loss types
Full
Liquidates all crypto assets when triggered. This is useful in a stable market with sudden unexpected price fluctuations, so that any price drop is predicted to remain low. While a surge backup will mean the trader loses out on potential profit, they will have avoided a loss if the price of crypto remains low.
Therefore, when setting a full stop loss, the trader must consider the risk and reward of both scenarios.
Partial
Liquidates a specified proportion of the digital assets when triggered. This can be useful in a highly volatile market (i.e. cryptocurrency market) to ensure the trader still has some assets remaining if the price drops before a surge. However, it leaves the trader with potentially unwanted assets, and if the price stays at a low level they will remain at a loss. This can be effective as an instrument of damage control in a highly volatile market, but it can’t guarantee the safety of the trader’s assets.It must therefore be used with the full understanding that the risks remain to be high.
Trailing stop loss
The stop loss value will adjust according to the crypto asset’s price fluctuations. The trader sets a trailing distance, which is the difference between the current asset price and the stop loss value. If the price of the cryptocurrency rises, the stop loss value will rise with it. When the price drops, the stop loss value will not change and a stop loss order will be triggered if the stated value is reached.
This has an advantage over set stop loss orders since it allows the trader to cap the maximum loss regardless of how far the trends have gone in their favor. What’s more, this frees the trader from having to manually adjust stop loss in response to the market. Trailing stop loss may become a liability in a steadily rising market, as strong rising trends often drop before continuing to grow. A low trailing distance could therefore result in the assets being liquidated before the price has reached its upper limit.
Risks
If full stop loss orders are set too high, the trader risks losing out on a price surge beyond the stop loss value. This is highly likely in a volatile market.
The trader risks losing out if the stop loss value is too low so the price drop doesn’t trigger it but then hits a steady trend after dropping. If the stop loss is triggered, the trader will lose more with a low stop loss value than with a high one, although it may have been a better choice if the trader believed the market would go back up after a drop that didn’t trigger stop loss.
While seemingly safer in a stable market, trailing stop loss, is a potential liability in strong upward trends.Partial stop loss is of little use in a stable market but can be of great help when trading with highly volatile new coins. That said, all risk comes with poor choices regarding the type and value of stop loss due to incorrect market analysis—much like any trading tool that can be damaging if not used properly.
Newbie tactic?
Some believe that stop loss is a tool used primarily (and ineffectively) by inexperienced traders—a belief that has some truth.. Stop loss can indeed be misleading for new traders since it’s sometimes seen as a failsafe rather than the complex and carefully planned insurance policy it should be when used appropriately. Yet in the hands of an experienced trader who’s good at market analysis, stop loss can be an invaluable tool that saves both time and money. Using it randomly, however, without understanding the purpose and application of each type of stop loss will cause damage. That said, inexperienced traders working within their depth in stable markets can make just as much use out of it, so long as they stick to strategies they understand well and manage their assets wisely. It comes as no surprise that trading in a highly volatile market is more difficult and has a lower success rates than trading with relatively stable coins. Attempts at damage control through stop loss (partial in this case) will be more difficult and less successful, but this is no reason not to try it if a trader is confident in their abilities.
Conclusion
While stop loss is designed to minimize damage caused by trend fluctuations, it does include some loss of assets and could end up being a waste of money. When choosing stop loss, crypto traders must consider the risk-reward ratio, as well as the importance of the traded asset to their portfolio. They should also be able to predict the general behavior of the market. Ultimately, stop loss is just a tool, and the choice to use it is based on the trader’s analysis of the market. Stop loss success depends on how well that analysis is carried out.
FAQ
How does a stop loss work?
Stop loss is a trading tool designed to limit the maximum loss of a trade by automatically liquidating assets once the market price reaches a specified value. There are multiple types of stop loss that can be used in different scenarios.
When should you set up a stop-loss?
Unlike a limit order, which aims to profit from the current trends, a cryptocurrency trader will use a stop loss order to limit potential losses to no more than they are able to take on.