What Is a Stop Loss in Trading? Definition, Types and Calculation

What is a stop-loss order?

A stop-loss order is an instruction sent to a broker that automatically closes an open position once the price reaches a level a trader sets in advance. The purpose is straightforward: limit further loss on a trade without needing to watch the market at every moment. Once the order is in place, execution is handled by the trading platform rather than by the trader manually closing the position.

Stop-loss orders are available on most CFD platforms, covering shares, currency pairs, indices and other instruments quoted for CFD trading. The mechanism stays the same regardless of the underlying instrument: the order sits inactive until the stop price is reached, and then it triggers.

Stop-loss vs take-profit orders

A stop-loss order limits the loss on a losing position, while a take-profit order closes a winning position once it reaches a target level, locking in gains. The two are typically set together before a trade is opened, and pairing them defines a risk-to-reward ratio for the position in advance.

How does a stop-loss order work?

Once a stop-loss order is placed, it stays inactive until the market price touches the stop level. At that point, the order converts into a market order and executes at the best price then available, which may differ from the exact stop level. The difference between the stop price and the actual execution price is called slippage, and it becomes more likely during high volatility or in fast, illiquid markets.

For example, a trader opens a position at $50 and sets a stop at $45. The position closes once the price reaches $45. In a fast-moving market, the order might fill at $44.80 rather than exactly $45, because the order converts to a market order instead of executing at a fixed price.

Stop-loss orders on long and short positions

On a long position, a stop-loss order is a sell order placed below the entry price; if the market falls to that level, the position closes. On a short position, a stop-loss order is a buy order placed above the entry price; if the market rises to that level, the position closes. Both directions use the same mechanism, on opposite sides of the entry price.

Types of stop-loss orders

Not all stop-loss orders work the same way, and the type used can change the outcome in a fast-moving market. There are four main types.

Standard (fixed) stop-loss orders

A standard stop-loss order is set at a specific price level and stays there unless changed manually. It is best used in calmer markets or on shorter timeframes, where large price gaps are less likely.

Trailing stop-loss orders

A trailing stop automatically moves with the price by a set distance or percentage, locking in profit as the position advances while still closing it if the market reverses by that same distance. It is best used in a position that is trending strongly, since the stop keeps adjusting without manual input.

Stop-limit order

A stop-limit order combines a stop price, which activates the order, with a limit price, which sets the minimum or maximum acceptable execution price. Because it only becomes a limit order once triggered, it can fail to execute at all if the market moves through the limit price too quickly, leaving the position open and unprotected. It is best used in markets that move gradually rather than around high-impact news events.

Guaranteed stop-loss order

A guaranteed stop-loss order (GSLO) is designed to close a position at the exact price a trader sets, even during a market gap or a sudden volatility spike. Brokers typically charge an added fee for this order type, since they take on the execution risk themselves; some refund the fee if the order is never triggered. It is best used when a large, sudden price gap is a specific concern, such as around a major scheduled news event.

Source: Investor

As a general rule: a trailing stop suits a position that is trending, a standard stop-loss order suits a shorter, range-bound trade, and a stop-limit order is best avoided in markets that are prone to sudden gaps.

How to calculate and place a stop-loss order

Most trading platforms allow a stop-loss order to be set when a position is opened, or added afterwards. A typical sequence looks like this:

1. Decide on the position and entry price before opening the trade.
2. Work out the stop level using one of the methods below.
3. Enter the stop-loss price in the order ticket alongside the trade.
4. Confirm the order and check that it appears on the open positions screen.
5. Review the stop level again if the position is held for an extended period, since account risk and market conditions can change.

A common decision at this stage concerns order duration: a Good-Till-Cancelled (GTC) stop stays active until it is manually removed, while a day order expires at the end of the trading session. It is worth checking which applies among the available trading order types before leaving a position unattended overnight.

Using the account-risk rule

A widely used method caps the loss on any single trade at 1-2% of total account capital, then works backwards to the stop distance. For example, on a $10,000 account, capital risk of 2% equals $200. If the position is 1 lot of EUR/USD, where one point of price movement is worth $10, the maximum affordable move is 200/10 = 20 points, so the stop-loss order is placed 20 points from the entry price. The position-sizing formula behind this method is: Position Size = Account Risk ÷ (Entry Price − Stop Price).

Using the Average True Range (ATR)

The Average True Range (ATR) is a technical indicator that measures typical price movement over a chosen period. Multiplying the ATR value by 1.5 to 2 produces a stop distance that adjusts for normal market noise rather than a fixed number of points, which can help avoid a stop that is too tight for current volatility.

Using support and resistance levels

Placing a stop-loss order just below a support level on a long position, or just above a resistance level on a short position, ties the stop to a technically meaningful point rather than an arbitrary distance. This method places the stop at the level where the original trade idea would be proven wrong, rather than at a random price.

Pros and cons of stop-loss orders

A stop-loss order has clear benefits, along with limitations worth knowing before relying on one.

Pros:

• Limits the loss on a single position to a level decided in advance.
• Reduces the need for constant monitoring, since the order executes on its own.
• Supports trading discipline by removing some in-the-moment decision-making.

Cons:

• Can close a position on normal price noise rather than an actual reversal.
• Execution price can differ from the stop level due to slippage in fast markets.
• Does not remove all risk: a market gap can still cause a loss beyond the planned stop.

Common stop-loss mistakes (and how to avoid them)

Setting the stop too close to entry. A stop placed just a few points from the entry price is often triggered by ordinary price fluctuation rather than a genuine reversal. Basing the distance on volatility or a technical level, instead of a fixed, arbitrary number, addresses this.

Using an arbitrary distance instead of market structure. Choosing a stop-loss distance because it feels comfortable, rather than because it sits beyond a support or resistance level, tends to produce inconsistent results across trades. Placing the stop at a level that would actually invalidate the trade idea addresses this.

Widening or cancelling a stop after the trade moves against the position. Adjusting a stop to avoid taking a loss increases the potential loss rather than reducing it, and defeats the purpose of setting one in the first place. Deciding the stop level before entering the trade and leaving it unchanged addresses this.

This behaviour is linked to the disposition effect, a bias documented in behavioural finance research in which traders tend to hold losing positions too long while closing winning ones early. Setting a stop-loss level before entering a trade, and leaving it unchanged once the trade is open, works directly against this bias.