Stop Loss (SL)

A stop loss (SL) is an order placed to automatically close a trade when the price of an asset reaches a certain level, designed to limit potential losses on a position.

It is a risk management tool that helps traders protect themselves from significant losses if the market moves against them.

For a long position, a stop loss is set below the entry price. If the market price falls to that level, the position is automatically closed to prevent further losses. For a short position, a stop loss is set above the entry price.

Stop loss orders offer several benefits to traders. It is a key tool for controlling risk. It allows traders to predefine the maximum amount they are willing to lose on a trade. By automatically closing the position when the price hits a certain level, it helps minimize large losses.

Such orders can also save time. With a stop loss in place, traders do not need to constantly monitor the market. It allows for more flexibility and frees up time since the trade will close automatically once the stop-loss level is triggered.

Still even though these orders are designed to limit losses, they can not prevent losses entirely. There are a few key reasons for this:

1. Slippage: in fast-moving or volatile markets, the price may fall (or rise) beyond the stop-loss level before the order can be executed. This is known as slippage and can result in a greater loss than initially anticipated;

2. Market gaps: in situations where there is a gap between the closing price of one trading session and the opening price of the next (such as over weekends or during major news events), the price may skip over the stop-loss level, and the position might not close at the intended price.

3. Market conditions: sometimes, the market can be illiquid or experience volatility, causing a delay in order execution, or the stop-loss order may not be triggered exactly at the desired level.

While a stop loss order can not prevent losses completely, it helps ensure that a trader's losses are kept within their risk tolerance, making it an essential part of a disciplined trading strategy.