What is a Stoploss Order ?
When a new trade is made with a Broker, a Stoploss order will instruct the Broker to close the position when a certain price is reached. It is designed to limit an investors losses on a trade. For example, lets say I entered a EURGBP trade at 0.899 with a Stoploss order of 0.898. This means that if EURGBP goes below 0.898, then the trade will automatically be closed by the Broker, limiting my losses.
The main advantage with a Stoploss order is that the trade does not need to be actively monitored. Stoploss orders can also be used to lock in profits. For example, lets say I entered a EURGBP trade at 0.899 with a Stoploss of 0.898. If the EURGBP goes up to 0.905, I could then move the Stoploss to 0.904 and lock in the profit from the trade.
The main disadvantage with a Stoploss order is that it could be activated by a short term fluctuation in the price. It is also important to realise that many Stoploss orders are not Guaranteed unless a “Guaranteed Stoploss Order” is purchased. For example, lets say I entered a EURGBP trade at 0.899 with a Stoploss of 0.898. If the EURGBP suddenly jumped from 0.899 to 0.895, then the trade will be closed at 0.895, not at the Stoploss price of 0.898. These jump’s in the market are commonly referred to as a GAP in the market or GAP events.
It is possible to purchase a “Guaranteed Stoploss Order”. Under these circumstances if the EURGBP suddenly jumped from 0.899 to 0.895, then the trade would be closed at a price of 0.898. However it has been my personal experience that Guaranteed Stoplosses are expensive. There is usually either an extra cost associated in purchasing the Stoploss or a larger spread is associated with the trade. At present I do not use them.
If a trade is entered and then moves close to the Stoploss level and if the account has a variable spread, it has been rumoured that the Broker may widen the Bid/Ask spread in order to execute the Stoploss and close the trade. I cannot confirm from personal experience if this is true, but it has been rumoured that some Brokers run computer algorithms to widen the spread if it gets close to the Stoploss.
In an attempt to avoid Stop Hunting, a number of computer trading algorithms use Hidden Stoplosses. When a trade is entered, it is commonly added without a Stoploss on the Broker account, but the computer algorithm stores an internal Stoploss level. The algorithm should then close the trade if the price goes past the Hidden Stoploss Level. This technique has the advantage of hiding the Stoploss level from the Broker, but if the connection between the algorithm and the broker goes down, then the Hidden Stoploss stops becoming active. I never use Hidden Stoplosses by themselves. I would prefer to enter a trade with both a Hidden Stoploss and a normal Broker Stoploss.