Stop Loss Order Meaning

Dec 20, 2023 | Updated Dec 20, 2023

A stop-loss order is a type of order investors preset to limit potential losses in an investment. It is automatically executed when a cryptocurrency value reaches a predetermined price level to protect the trader from excessive losses.

What is a Stop-Loss Order?

Timing is everything in the financial markets, especially in volatile markets like the cryptocurrency market. Thus, understanding when to enter and exit positions can be profitable or minimize potential losses. For instance, suppose a trader purchased one BTC at $10,000, anticipating the price will rise over time. If the price declines instead, the trader is likely to incur some losses. Since the trader does not know whether the market will recover or not, they have to exit their positions before they can experience further losses. The trader, for instance, can set a condition to exit the market when the BTC price reaches $9,800. The trader is said to have set a stop-loss order.

A stop-loss order defines the predetermined price an investor is willing to sell their cryptocurrency asset to close a losing position. It is often set to automatically trigger a sell order at a price level that is below the current price. It is also a way for investors to lock in profits by pairing it with a trailing stop.

How Does It Work?

In this order type, investors specify the lowest price (stop price) they are willing to sell their crypto assets. If the asset’s value reaches the stop price, the order becomes a market order and a sell order is immediately triggered. Typically, the asset is sold at the best available price. It is noteworthy that stop-loss does not prevent losses but rather limits losses.

One of its primary benefits is that it relieves investors from constantly monitoring the market. This eliminates the risks of emotional trading and FUD, allowing traders to stick to their trading plans and strategies. Since orders are automatically executed, it guarantees investors that the asset will be sold when the stop price is reached. This saves time and ensures traders exit a position before it is too late.

Potential drawbacks of this tool include price slippage and premature exits. Slippage occurs in illiquid or volatile markets where the sell order is triggered at a much worse price than the stop price. In addition, it may lead to a premature exit due to a temporary price movement. This leads to missing out on profitable opportunities when the market recovers.