What is a CFDs Stop Loss Order? & Factors to Consider When Setting

Stop Loss Order is a type of order that's set after opening a trade that is intended to minimize losses if the market moves against you in the opposite direction.

It is a predetermined point of exiting a losing transaction & it's meant to control losses.

A stop loss is an order placed with your cfd broker that will automatically close your cfd trade transaction when it reaches a predetermined cfds price. When set level is reached, your open trade is liquidated.

These cfd orders are designed to cap the amount of money which one-can lose: by exiting the transaction if a specific price that's against the trade is reached.

Regardless of what you might be told by others, there is no question about whether these trading orders should or should not be set - these orders should always be set.

One of the more challenging things in in CFD Trading is setting these orders. Put the stop loss too close to your entry price & you're liable to exit the trade position because of some random market volatility. Put it-toothe-stop-loss-order-too far away & if you are on the wrong side of the trend, then a small loss may turn into a big one.

Critics will point out several disadvantages of these orders: that by placing them you are guaranteeing that, should your open position move in the wrong direction, you'll end up selling at lower cfd prices, not higher.

Skeptics will also argue that in setting stops you are vulnerable to exit a transaction just before the cfd market moves in your favor. Most investors have had the experience of setting a these orders & then seeing the price retrace to that level, or just below it, & then go in the direction of their original market cfd trend analysis. What might have been a profitable trade transaction rather turns into a loss.

Experienced traders always use stop loss orders as they are an important part of the discipline that is required to succeed because they can prevent a small loss from becoming a big one. What's more, by ardently placing these orders whenever you enter a position, you end up making this important decision at the point in time when you are most objective about what is really happening with cfd market, this is because the most unbiased analysis is done before entering a trade position. After entering the cfd market an investor will tend to analyze the cfd market differently because they have a bias towards one-sidea-particular-side, the direction of their market technical analysis.

Unexpected news can come out of the blue & significantly affect the cfd price: this is why it is so important to have a stop loss order. Its best to cut losses early when a trade transaction is going against you, it's best to cut your losses immediately instead of waiting it to become a large one. Again, if you put your stop orders when you're entering a trade position, then that is when you're most objective.

A key question is exactly where to place a this order. In other words, how far should you place this below your purchase cfd price? Many traders will tell you to set pre-determined - max acceptable loss, an amount that is based on your account balance rather than use technical indicators of the cfd in question.

Professional money managers advice that you shouldn't lose more than 2% of your trading account equity on any one single cfd transaction. If you have $50,000 in capital, that then would mean the max loss that you should preset for any one transaction is $1,000.

If you bought 1 standard lot of a cfd instrument, then you'd cap your trading risk to no more than $1,000. In which case you would put your stop order at 100 pips (points) & would have $49,000 left in your trading account if you exited the trade position at the max loss allowed. The topic of CFD Trading risk management is wide & it is covered in the money management topics.

• CFDs Money Management Introduction
• CFDs Money Management Methods

Factors to Consider When Setting

The most important question is how close or how far this order should be from the price where you entered the position. Where you set will depend on several factors:

Since there aren't any rules cast in stone as to where you should set these levels on a cfd chart, we follow general guidelines that are used to help put these levels correctly.

Some of the general guidelines used are:

1. Risk - How much is one willing to lose on one transaction. General rule is that a trader should never lose more than 2 percent of the total account capital on any one single transaction.

2. Volatility - this refers to the daily price range of a cfd. If a cfd price routinely moves up & down in a trading range of 100 pips or more during the course of the day, then you cannot put a tight stop order. If you do, you'll be taken out of the trade transaction by the normal market volatility.

3. Risk to reward ratio - this is the measure of potential reward to risk. If the cfd market conditions are favorable then it's possible to comfortably give your trade more room. However, if the cfd market is too choppy it then becomes too risky to open a transaction without a tight stop then don't make the trade at all. The risk to reward ratio is not in your favor & even putting tight stop loss orders will not guarantee profitable results. It would be more wiser to look for a much better trade transaction next time.

4. Position size - if the position size opened is too big then even the smallest decimal price movement will be fairly large in percentage terms. This means that you have to put a tight stop loss which might be taken out more easily. In many cases it's better to shift to a smaller trade position size so-as-tosothat-to give your trade transaction more room for fluctuation, by putting a rational level for this order while at same time capping the risk.

5. Account Capital - If your account is under-capitalized then you'll not be able to set your stops accordingly, because you'll have a large sum of money in a single trade position which will constrain you to set very tight stops. If this is the case, you should contemplate very seriously about if you have adequate trading capital to trade CFD in the first place.

6. Market conditions - If the price is trending upwards, a tight stop may not be necessary. If on the other hand the price is choppy & has no clear direction then you should use a tight stop loss order or not execute any transactions at all.

7. Chart Timeframe - the bigger the chart time frame you use, the bigger the stop should be. If you were a scalping your stops would be tighter than if you were a day or a swing trader. This is because if you are using longer trading chart time frames and you determine the price will be move up it doesn't make sense to set a very tight stop because if the price swings just a little, your order will be hit.

The technique of setting that you choose will mostly depend on what type of trader you are. Most oftenly used technique to determine where to set is - resistance & support levels. These areas give good points for setting these stop loss orders as they are most dependable regions, because the support & resistance areas will not be hit many times.

The guide of how to set these stops that you select should also follow the guide-lines above, even if not all those who apply to your cfd strategy.