What kind of stop-loss order should a trader use?

In this article we will discuss the various ways to implement a stop loss order. Every trader who has had dealings in any of the financial markets is familiar with placing and executing a stop loss order, but many are mistaken that a stop loss order is always numerical. On the contrary, there are many traders (even professional hedge fund managers) who use what is colloquially termed a “mental stop” which stop is a stop loss point determined by factors other than the price, such as events, volatility, volume, option positioning, or any other comparable data. Such a stop is no less valid than a numerical one, and certainly no less effective, but one does need a lot more discipline to execute it successfully.

The great advantage of a non-numerical stop-loss order is its partial immunity to price swings. If the trader has confidence in his analysis, and is satisfied that standing firm in the face of market volatility is sensible and acceptable given the major dynamics and currents in the market, maintaining positions with non-numerical stop loss orders can be advisable and lucrative. In order to manage the inevitable large swings in account value, professional managers will implement hedging strategies in addition to money management methods, to control and minimize the volatility of the portfolio. Thus, even if the mental stop triggers a large drawndown in our position, we can minimize the effect on the portfolio through diversifying and distributing the risk among various currency pairs.

Let us examine the various ways of implementing a stop-loss order now.