V.11:10 (440-442): The Importance of Stop Orders by Patrick Cifaldi, C.M.T.

The Importance of Stop Orders by Patrick Cifaldi, C.M.T.

Some traders view stop orders as an affront to their analytical skills, but they shouldn't. Here are some simple guidelines on using stop orders and saving yourself some painful and costly lessons.

Stop orders are a necessary part of trading. Stop orders have price trigger points that modify them from resting orders to be filled at the market if the trigger price is traded at or through during market hours. Stop orders are used to initiate trades, lock in profits and limit losses on existing trades. Of these, sell-stop orders are placed below current prices, while buy-stop orders are placed above current prices.

Stop orders can be used to manage the risk on trades. For example, if a trader were to take a long position and then place a sell-stop order with a specific price — that is, an August gold contract trading at $392 — then the sell order might be "Sell one August gold contract with a 388.80 stop," which is placed below m, the current market price. If the market then trades down to the stop-level price, the order then becomes an instruction to sell at the market and either limits the loss on the long position or locks in the profit. If a trader takes a short position, a buy-stop order is placed above the market. If the price rallies to the stop-order price, the order then becomes an instruction to buy at the market, just as if an order to buy had been placed.