Stop Loss VS Stop Limit

Trading Made Easy 2022-07-25 14:55:18

Crypto traders operate under volitality, it is crucial to know the difference in Stop-loss & Stop-limit.


Investors and traders participating in financial markets, whether they are crypto, stock, or commodity exchanges, use trading instructions to direct their activities. These instructions are referred to as orders and are useful in preventing losses when traders might not be able to manually input their instructions. There are various types of orders used for various purposes. Still, there are two orders in particular that every crypto trader should be familiar with - Stop Loss and Stop Limit orders.


Let's get right into it.


Stop-Loss Orders


Stop-loss orders will typically be used to sell off holdings if their prices fall to a certain specified point. They can be useful in protecting long positions (where traders invest, expecting prices to rise) as they will automatically trigger a sell order should prices show a downward trend. The logic behind this is that prices might be on their way to decline even further, thus protecting the trader from even greater losses. Just like tying off a cut vein to stop further blood loss, a stop-loss order will shut off what seems like a running loss.


Let's take the example of an investor who has purchased 100 units of crypto XY at $10 per unit. After rumors spread in the market that the crypto is about to be made acceptable as a payment currency by a certain credit card company, the price per unit of crypto XY shoots up to $20 per unit. 


Now, should the trader wish to guarantee that their gains are not eroded in case the prices plummet in the future without selling off his crypto holding immediately, they will have the option of putting a stop-loss order in place. In this example, the trader might place a stop-loss order at $15 per unit. This way, should the crypto fall to $15, it will automatically be placed on the market for sale. The trader might not receive the full $15 for every crypto they sell if the price is continually dropping, but they will still retain a good chunk of the earnings they had made. 


Once a stop-loss order is triggered, the sell instructions will still be in place whether or not the price rebounds upwards or not. So, if the price for crypto XY hits $15 for a moment and starts climbing back up immediately to $16 and beyond, it will still be on the market until the trader places further instructions.


Stop Limit Orders


There is a subtle difference between stop loss and stop-limit orders, but the distinction is important. While both orders will have the effect of placing an asset on the market once its value drops to a certain point, putting a stop-limit order in place will put a halt to the selling activity in case the price plummets to a point even further below the trader's stop-loss point.


Let's continue with the hypothetical scenario mentioned above. The investor who had placed a $15 stop order on crypto XY might notice that prices rebound upwards before hitting the stop-loss point and continue to climb until they hit a price of $25. At this point, the trader might choose to cancel the first stop-loss order and place a new one at $23, with a stop-limit order at $20. 


The effect of these actions will be that should the value fall once again below $23, the shares will be put up for sale, but if they get past $20, they will be taken off the market until they climb back above the $20 level. While there is never any guarantee that the order will be filled or bought up at these levels, the essential point of placing a stop-limit order on an asset is to hold on to it, hoping that it will soon recover its value. Gains can thus be preserved in times of market uncertainty.


Importance of Stop-Loss and Stop-Limit Orders for Crypto Traders

Crypto traders operate in an environment where values can increase or decrease dramatically over a day or even a few minutes. They need to have tools in place that help them mitigate the risks involved in operating within such volatile markets, and the stop-loss and stop-limit orders provide this functionality.


While a stop-loss order will cut off the losses incurred when a trader's assets are experiencing a downward trend, stop-limit orders give them the opportunity to keep their portfolio activity or fluctuations within a narrow-predetermined band, just in case prices might bounce back up in the future.


One potential pitfall that stop-limit orders present to traders can be illustrated in this way: say a trader in our example is holding crypto XY with a stop limit of $20, and the price falls very rapidly below this limit and settles at $18. If the prices plummet too fast for them to have a chance to sell below their stop loss point, then they will now be stuck with the crypto holding. They will not be able to recover their investment, and so their stop-limit order will have magnified their losses.


When considering stop-loss vs. stop-limit options in your trading activities, users should always gather as much information as they possibly can about the crypto assets in question. They should always familiarize themselves with the trading tools at their disposal and how to make the best use of them before diving into the world of crypto investment. Technical analysis methods are highly useful resources for beginners and expert traders, and traders who implement these best practices will maximize their chances of success.


Final Thoughts


Stop-loss orders instruct that assets should be sold immediately but do not guarantee that they will be purchased at a price set by the trader, as prices might still be in motion during the transaction window. With this in mind, the use of stop-limit orders will guarantee that assets are sold off once they fall below a certain point below the stop-loss value, creating a band within which a trader will ensure their profits. 


The combination of these two tools is a highly useful one for traders operating in volatile markets and one that every crypto trader should consider.


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