What is a Commodity StopLoss Order? & Factors to Consider When Setting
Stop Loss Commodity Trading Order is a type of order that is placed after opening a trade that is designed to minimize losses if the commodity market moves against you.
It's a preplanned level of getting out of a losing trade transaction and it's designed to control losses.
A stop loss is an order placed with your commodity broker that will automatically close your commodity trade transaction when it reaches a predetermined commodities trading price. When set level is reached, your open trade is liquidated.
These commodity orders are intended to restrict the sum of money which trader can lose: by exiting the transaction if a specific commodities trading price that is against the trade is reached.
Regardless of what you may be told by others, there is no question about whether these trading orders should or shouldn't be used - they should always be used.
One of the more challenging things in in Commodity Trading is setting these orders. Put the stop loss too close to your entry commodities trading price & you're liable to exit the trade due to random market volatility. Place it too far away and if you are on the wrong side of the trend, then a small loss could turn into a large 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 will end up selling at lower commodities trading prices, not higher.
The critics will also argue that in setting stops you are vulnerable to exit a transaction just before the commodity market moves in your favor. Most investors have had the experience of setting a these orders and then seeing the commodities trading price retrace to that level, or just below it, and then go in the direction of their original market commodity trend analysis. What may have been a profitable trade position now 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 commodity market, this is because the most objective technical analysis is done before opening a trade transaction. After opening the commodity market a trader will tend to interpret the commodity market differently because now they have a bias towards one-sidea-particular-side, the direction of their market technical analysis.
Unexpected news can come out of the blue & dramatically affect the commodities price: this is why it is so important to have a stop loss. Its best to cut losses early when a position is going against you, it's best to cut your losses immediately rather than waiting it to become a big one. Again, if you set your stop loss orders when you are entering a trade transaction, then that's when you are most unbiased.
A key question is exactly where to place a this order. In other words, how far should you place this below your purchase commodities trading price? Many traders will tell you to set pre-determined - maximum acceptable loss, an amount that's based on your trading account balance rather than use of technical indicators of the commodity instrument in question.
Experienced money managers instruct that you should not lose more than 2 percent of your trading account equity on any single commodity transaction. If you have $50,000 in trading capital, then that would mean the max loss that you should preset for any one transaction is $1,000.
If you bought 1 standard lot of a commodity instrument, then you'd limit your risk to no more than $1,000. In that case you'd set your stop loss order at 100 pips (points) and would have $49,000 left in your account if you closed the trade transaction at the maximum loss allowed. The topic of Commodity Trading risk management is wide & it is covered under money management topics.
Factors to Consider When Setting
The most important question is how close or how far this order should be from the commodities price where you entered the position. Where you set will depend on several factors:
Because there are no guidelines cast in a stone as to where you should put these levels on a commodity 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 a single transaction. General rule is that a trader should never lose more than 2 percentage of the total account capital on any one single transaction.
2. Volatility - this refers to the daily commodities trading price range of a commodity. If a commodity instrument regularly moves up and down in a range of 100 pips or more over the course of the day, then you can't set a tight stop loss 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 commodity market conditions are favorable then it is possible to comfortably give your trade more room. However, if the commodity 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 isn't in your favor and even placing tight stop orders won't guarantee profitable results. It would be more wiser to look for a better trade position the next time.
4. Position size - if the position size opened is too big then even the smallest decimal commodities trading price movement will be fairly large in percentage terms. This means that you've to set a tight stop which might be taken out more easily. In most cases it's better to adjust to a smaller trade position size so-as-tosothat-to allow your trade position more space for fluctuating, by placing a fair level for this order while at the same time limiting the risk.
5. Account Capital - If your account is under-capitalized then you will not be able to set your stops accordingly, because you'll have a large sum of money in a single trade transaction which will obligate you to put very close stops. If this is case, you should think seriously about whether you've enough capital to trade Commodity in the first place.
6. Market conditions - If the commodities trading price is trending upward, a tight stop might not be necessary. If on the other hand the commodities price is choppy and has no clear direction then you should use a tight stop loss order or not open any positions at all.
7. Chart Time frame - the bigger the chart time frame you use, the bigger the stop should be. If you were a scalper trader your stops would be much tighter than if you were a day or a swing trader. This is because if you're using longer chart timeframes & you determine the commodities trading price will be move upwards it doesn't make any sense to put a very closetight stop loss order because if the commodities trading price swings a little, your order will be hit.
The technique of setting that you select will vastly depend on what type of trader you're. Most commonly used method to determine where to set is - resistance and support zones. These areas give good points for setting these stop orders as they are the most reliable zones, because the support and resistance levels won't be hit many times.
The technique of how to set these stops that you choose should also follow the guidelines above, even if not all those who apply to your commodities trading strategy.
