To be successful in crypto trading, one must understand the various approaches to employ so as to maximize profits while properly managing risks. Some of the risk management techniques include setting stop loss and using stop limit orders. This article focuses on these two. We will discuss the weaknesses and strengths of each.
What’s a Stop Loss Order?
Simply put, a stop loss order is a trader’s instruction to a broker or crypto exchange to automatically sell a token if its price falls to a predetermined price. The traders use stop loss orders to avoid blowing their trading accounts. In addition, they set stop losses according to their level of risk tolerance. It is worth highlighting that a trader can adjust stop losses even after sending their orders to the market.
Pros of Stop Loss Orders
Stop loss orders carry several benefits. They include:
Limit losses: When traders set a price at which a sell order is automatically triggered when a trade does not go as predicted, it helps them to limit potential losses. That said, stop loss orders are useful in the highly volatile crypto market as price change quickly.
Automated process: Since stop losses are predefined, traders do not have to monitor their traders continuously. This helps them to save the time required to track price movements.
Emotion control: Traders can get emotional when a crypto asset price starts moving in an unexpected direction, causing them to engage in panic selling. However, by predetermining a selling point, you won’t have to worry when the market begins a downturn.
Risk management: As mentioned earlier, a stop loss order is a great risk control tool. By limiting the amount you are willing to lose, you are able to handle risk exposure properly.
Flexibility: Traders can set stop loss orders at any price, thus providing them with the required flexibility. In addition, they can adjust their stop losses to accommodate market changes.
Cost-effective: Traders do not incur any extra charges for placing stop loss orders.
Exit strategy: Considering how volatile the crypto market is, a trader needs an exit strategy to shield them from sudden market downturns. Stop loss order can perfectly serve this purpose.
Cons of Stop Loss Orders
Here are some disadvantages of stop loss orders.
Market volatility: Since volatility in the crypto market is high, it may cause temporary price swings that may hit stop losses, prompting unwanted exit from the market.
Psychological impact: poor use of stop loss orders may lead to a trader getting stopped out of a trade prematurely. For instance, when they set stop loss too close to the entry price.
Possible manipulation: In some markets, the market makers see stop loss orders. This means they can artificially drive a token’s price toward stop losses to collect liquidity.
Difficult to understand for newbies: Stop loss orders can be complex to use for beginners. This causes them to make mistakes, losing funds in the process.
What’s Stop Limit Order?
Stop limit orders involve traders setting a stop loss along with a limit price. That means a limit order automatically becomes active when a digital asset triggers the stop loss. However, the order is only executed once the limit price is reached.
Here is an example, let’s say today you notice Ethereum is trending downward. So you open a stop limit order, with the stop loss at $1,780 and the limit price at $1,750. Once Ethereum reaches $1,780, the broker or the crypto exchange automatically places a buy order, but it will be executed when the price hits $1,750. Note that your order won’t be filled if the ETH touches the stop loss but fails to trigger the limit price.
Pros of Stop Limit Order
Facilitates strategic trading: Stop limit orders help traders enter the market in a strategic manner as they only trade once some specific conditions are fulfilled.
Cons of Stop Limit Order
Execution is not guaranteed: If a token’s price fails to reach a limit price, your order will not be executed, meaning you may miss some good trading opportunities.
As you can see, both stop limit and stop loss orders are good risk management tools. You can apply them in your trading strategy depending on your objectives.
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