In spot trading, stop orders can be used as both standalone and complementary orders. However, this order type is typically not often used on its own because a limit order can achieve similar goals.
Thus, stop orders are sometimes viewed as add-ons, which may help protect existing trades from unexpected price movements, and limit potential losses. In addition, they empower traders to define preferred levels to exit the market. The utility and relevant strategies may depend on which stop order type you use.
Stop order varieties
A stop order is the equivalent of saying “when the price reaches X level, I want to buy/sell an asset.” Depending on how you want to buy/sell it, stop orders are divided into several types. In spot trading, they include:
- Stop Market
- Stop Limit
Stop orders are considered conditional order types, meaning they are executed only when specific market conditions are met. Regardless of the stop order type, all include a so-called stop level. It acts as a trigger that activates the trade.
Stop Market
A Stop Market is the order type that transforms into a market order once the price reaches a stop level. This guarantees the order execution, but not the price. This means that these stop orders are prone to experiencing price slippages if there is a lack of liquidity, or increased volatility, in the market.
Example: Let’s say a trader wants to buy Bitcoin when the price reaches $25,000. For that, they need to set $25,000 as a stop level. Once the asset price gets to $25,000, a market order will be placed, and executed immediately.
Many traders like to call Stop Market orders as stop loss, because this order type is widely used as a complementary order to protect existing trades. However, in spot trading, it can also act as a standalone pending order to enter, or exit, the market.
Stop Limit
As the name suggests, a Stop Limit transforms into a limit order once the price reaches a stop level. This offers price protection, but not order execution, meaning Stop Limit can be partially filled, or not completed at all. For example, this may happen if the market has relatively low liquidity, or if the price doesn’t reach a stop level.
Example: Let’s say a trader wants to buy Bitcoin when the price reaches $25,000, but for no more than $25,200. For that, they set up $25,000 as a stop level, and $25,200 as a limit point. Once the asset price gets to $25,000, the order will start to fill. As long as the order can be filled under $25,200, the trade will be completed.
Stop Limit orders are typically viewed as a way to mitigate potential risks of illiquid markets and price volatility. They provide traders with more control over the fulfillment of their orders, and empower them to buy/sell assets in a preferred range.
However, additional analysis is required to find a balanced gap between spot and limit levels, in order to avoid unpleasant financial results.
CTA: Try Stop Limit on Exchange Plus
Where to place a stop order
There is no general answer on where traders should place their stop orders. But there are two rational methods for defining potentially appropriate areas: financial and technical.
Financial method
A financial stop order is placed at a fiscal point where a trader wants to enter, or exit, the market depending upon their own risk tolerance.
Example: Let’s say a trader bought Bitcoin at $25,000, and anticipates an upward movement. However, they are not willing to risk more than $500. In this case, they can set up a complementary order with a stop level at $24,500 ($500 below the initial price) to protect the first trade.
Technical method
A technical stop order is placed near major price levels, which can be found after performing a technical analysis. For instance, these levels could be previous highs and lows, specific moving averages, or Fibonacci retracement points.
Example: Let’s say the Bitcoin price is $25,000, and a trader anticipates that the bullish movement will accelerate after a breakout of the $26,000 resistance level. They can place an order with a stop level at $26,050 (slightly above, because the asset could test the resistance level) to enter the market once the breakout is confirmed.
Stop order practices in spot trading
Stop Loss
Not every trade can be successful, and the market may move against your strategy. Because of this, many experienced traders accompany all their trades with stop orders as a protection against unexpected price movements. A stop loss can limit your losses around a specified, defined price level.
Take Profit
When markets move in your favor, it’s tempting to say “I will wait a bit more, and then sell.” But if you do not monitor the price movement at all times, you may not be there to sell the asset when the price reaches the desired level. To ensure that happens, a trader may want to place a pending stop-sell order to exit the market at a predetermined point, also known as “take profit.” When a trader has an exit level, this can help make trades more organized.
Moving stop orders
If the market moves in the direction of your trade, you could replace stop loss. In this way, if the price suddenly moves against your trade, you could sell the asset at a better price compared to the initial trade. Typically, stop orders are moved based on the percentage difference between the market price and stop orders, or based on the preferred range in absolute numbers.
Example: Let’s say a trader bought Bitcoin at $25,000, and set a stop loss with a $500 difference ($24,500). The price moved to $26,000, and the trader replaced a stop loss to $25,500. The market trend reverted, and dropped below $24,500. However, the trader sold the asset at $25,500 and saved $1,000, because they earlier replaced a stop loss.
It should be noted that the process of moving stop orders can be automated using so-called trailing stops. However, these order types are typically available only when trading futures, options, or on margin. It’s possible to use trailing stops on spot markets, but it may require setting up a trading bot.
Conclusion
As a general rule, experienced traders create a complete strategy for each trade before entering the market. For that, they define the entry level, stop loss, and take profit. In spot trading, all of that can be set up using stop orders.
Thus, this order type is considered a major risk management tool, which may help mitigate potential risks of price volatility, and avoid emotional uncertainty.
Disclaimer: For information purposes only. Not investment or financial advice. Seek professional advice. Digital assets involve risk. Do your own research.
