There are a lot of terms in cryptocurrency trading that may have you scratching your head. Stop Loss is one such term, and it’s not the easiest thing to understand. This article will teach what stop loss means, why it’s important for traders to use them correctly, and how they work with other order types when putting orders on an exchange or broker. By the end of this article you should be more confident about using stop losses effectively without losing money in the process.
What Is a Stop-Loss Order?
A stop-loss order is an order placed with a broker to buy or sell a security when it reaches a certain price. For example, if you are worried that the market will drop and your stock will lose value, you can place a stop-loss order at $30 below the current market price. This means that your broker will automatically sell your stock when it reaches $30 below the current market price. Stop-loss orders are different from stop-limit orders, which we will discuss next.
A stop-loss order is an order to sell a security when it reaches a certain price. For example, if you are worried that the stock you bought will go down, you can set a stop-loss order for 10% below your purchase price. If the stock falls to that price, the order becomes a market order and it executes at the next available price.
For instance, suppose you purchased BTC at a price of $40,000; if the price continues to rise, you will benefit; however, if the price continues to fall, you would lose. Simple mathematics, no rocket science required!!
And in a case when prices begin to decline, the goal is to protect oneself from loss using the stop-loss mechanism. In this example, one places a sell order at a price slightly less than the actual buy price. For instance, if we place a stop-loss sell order at $39,900, the stop-loss will be triggered and BTC will be sold at that price.
While some may argue that this is still a loss of $100, the purpose of the stop-loss is to limit the amount of losses experienced by the trader in the case of a sharp decline in the price of a cryptocurrency.
Types of Stop loss in Cryptocurrency
Stop loss is a feature in cryptocurrency that helps prevent losses during turbulent times. There are basically four types of stop loss:
- Complet stop loss
- Partial stop loss
- Indirect stop loss
- Trailing stop loss
To illustrate the various sorts of stop losses, consider that you slept without establishing a stop-loss and that during that time period, the price of BTC begins to fall apart, and within an hour, it has fallen 30% from the price at which you purchased. As you can see, stop losses allow you to hedge your risk when you are away from your computer. This is referred to as a complete stop-loss, and it occurs when the entire amount acquired is sold in the case of a stop-loss.
Another sort of stop-loss is a partial stop-loss, in which you opt to sell half or a portion of the cryptocurrency you acquired in response to an occurrence that triggers a stop-loss order. This form of stop-loss becomes critical in a volatile market like cryptocurrency.
Assume you acquired 50 ETH at a cost of $1,000 apiece and placed a complete stop-loss order at $900 before going to sleep. As the price declines, the stop-loss at $900 is triggered, resulting in the selling of all ETH to avoid additional losses. You lost $5,000 (50*100$) in this case, but the price of ETH had already exceeded the $1050 mark the next morning due to volatility. Now, you will be obliged to purchase ETH at a price that is even greater than what you paid a day earlier; this is an indirect loss. However, if you had used a partial stop-loss, the loss would have been far less.
Another more complex type of stop-loss is the trailing stop-loss, although this type of stop-loss is not available on any exchange. However, in my opinion, this is the most acceptable stop-loss strategy for such a volatile business.
Stop-Loss vs. Stop-Limit Order: Which Order to Use?
Indeed, many individuals become perplexed by the terms but allow me to clarify that stop-loss order and stop-limit order are the same.
After a stated (or potentially better) stop price is reached, a stop-limit order will be executed at the specified (or potentially better) price. Once the stop price is achieved, the stop-limit order transforms into a limit order to buy or sell at the limit price or a higher price.
The distinction between the two becomes apparent when the price reaches the stop. When a stop-loss order is executed, the trade is automatically closed. The disadvantage is that the position may not necessarily close at the stop-loss price indicated in the order, which may occur during flash crashes or gaps.
Thus, in the instance of the stop-limit order, when the price reaches the stop, the limit order is triggered, which executes only if the price reaches the limit price. The stop-limit order allows traders greater control over the prices at which a market exit occurs. Stop-loss orders, on the other hand, are more convenient to use and can help reduce losses.
How To Calculate Stop Loss in Cryptocurrency Trading
In order to calculate a stop loss in cryptocurrency trading, you need to understand volatility. Volatility is a measure of how much the price of an asset changes over time. It can be used as an indicator to help you determine whether or not an investment is worth exploring further.
Most importantly, traders should use stop losses sparingly in order to minimize losses and maximize profits. If a stop loss is set too low, the trader risks selling at a loss. Conversely, if the stop loss is set too high, the trader risks not selling when the price reaches that point. In either case, it’s important to be aware of how one’s own trading strategy can be improved by using a stop loss.
How To Set A Stop Loss on Binance
Stop loss is a trading tool that allows you to minimize losses in your investment. When you set a stop loss, you are telling the exchange to sell your coins if they fall below a certain price. This can help protect you from losing too much money if the market takes a turn for the worse. Always be sure to set a limit so that you don’t lose all of your investment.
Log into your Binance account and watch this video tutorial below to learn how to utilize stop loss and stop limit orders on the Binance exchange.
Benefits and Risks of Stop-Loss and Stop-Limit Orders
- Stop-loss and stop-limit orders help protect a trader from losses in the event of a market crash.
- Stop-loss orders close out a position when it falls to a certain price, while stop-limit orders determine a “limit price” and do not execute until the price reaches that level.
- Stop-limit orders operate as Good till Canceled (GTC) orders by default.
- A limit order is a request to buy or sell an asset at a specified price, but the order may get filled at a better price, but the price limit is a prerequisite.
- Stop-loss and stop-limit orders are types of orders that guarantee a limit price.
- Stop-loss orders protect profits, while stop-limit orders protect losses.
- Stop-loss and stop-limit orders are used to manage risks in cryptocurrency spot trading.
Technical analysis is important for understanding which order type to use and where to place them.
Can a Stop-Loss Lead to Disaster while Trading?
Yes, stop loss is a strategy in which an investor can limit his or her losses by setting a price point at which they are willing to sell their asset. This means that the stop-loss order will automatically be placed when the price of your asset reaches this point. So if you are a long-term investor, then stop loss is not for you. It is only useful for investors who want to trade.
When markets are volatile, it is perfectly viable for an asset’s price to fluctuate dramatically. This is true of Bitcoin. It is not uncommon for the price to plummet by 5% and then return in a matter of seconds.
This also applies to other cryptocurrencies. The cryptocurrency industry as a whole is somewhat minor in comparison to more established markets. As a result, market manipulation is not ruled out.
Heavy Bitcoin holders, or “whales,” may easily manipulate the market in their favor. For example, a whale may go to a spot exchange and begin selling Bitcoin to drive the price down, while simultaneously maintaining a heavily leveraged short position on an exchange that enables margin trading to profit from the decline. Then, after the price has fallen, the market immediately recovers and the price returns to its previous level.
In this case, a stop-loss order may be detrimental, since it will sell your position at the trigger price. In this manner, you’ll exit the deal before the price recovers, which typically occurs rapidly, particularly with Bitcoin.
Rather than putting actual stop-loss orders while trading Cryptocurrencies, it is sometimes more prudent to have one predetermined in your head. In this manner, you may examine the situation and decide whether or not it is worthwhile to exit your position for a loss, without really placing a stop-loss order that can be forced closed, as in the preceding instance. Bear in mind, however, that you will need to visit the market periodically to keep an eye on the current price.
Finally, stop-loss or stop-limit orders allow you flexibility and aid in risk management during the volatile moments of the bitcoin market. While using this function, one does not need to be constantly in front of their computer, and if utilized intelligently, a great deal of loss may be avoided, which finally results in your profit.