When people first hear about them, many people who trade foreign exchange ask the question, “What is a stop loss order?” Basically, these orders are tolls that limit losses and reduce risk exposure.

With one of these orders, you enter an order to exit a traditional position that you hold if the price of your investment falls to a particular level that represents a specified amount of loss in the trade. A stop loss order allows you to limit your risk in the trade to a specified amount if or when the market moves against you.

To illustrate this with an example, you enter a buy position by entering the market at 1.2980, expecting the market to rise, while also knowing that the market is unpredictable, and that it might do the opposite and fall. Before entering the market, you calculate the risk and place a stop loss order below the entry price, predefining the stop loss price at 1.2880. If the bid price hits the stop loss price, the position closes, ensuring a minimum loss for you.

Alternatively, you can place a protective stop loss order at a higher level than the entry price in case the market rises after you enter a sell position when expecting the market to fall. If the ask price reaches the predefined stop loss price, the position closes and ensures a minimum loss for you.

The purpose of a stop loss order

The purpose of a stop loss order is to reduce risk exposure by limiting potential losses. A secondary purpose is to make trading easier by placing an order that will execute automatically if a foreign exchange market trades at a specified price.

It’s a good idea to use stop loss orders whenever you enter a trade, as this can reduce risk and protect you from potentially damaging losses.

The difference between stop loss and limit orders

FX orders are instructions that you give to FX dealers, and these instructions dictate when and how you want to exchange currency. Two of the three options available at Moneycorp are stop loss and limit orders.

Take a closer look at the difference between stop loss and limit orders.

As mentioned, you can use stop loss orders when you expect the rate to move against you, helping you to mitigate your risk of exposure to currency market fluctuations. They ensure that you don’t suffer from exchange rates that are worse than expected.

Limit orders are the opposite of stop loss orders. You can use limit orders when you’re looking to buy currency at a better value than the current exchange rate. These orders are best for when you think that your required currency will see a positive upward trend. To use a limit order, you set the desired exchange rate. If or when the market reaches that rate, your exchange will go through automatically. These orders are especially helpful in markets where rates can change quickly, as they allow you to set the maximum and/or minimum price that you are willing to pay. Of course, there’s no guarantee that the market will reach your desired rate, meaning your order could go unfulfilled.

Advantages and disadvantages of a stop loss order

It’s important to understand the advantages and disadvantages of stop loss orders before deciding to use them for your FX.

One of the biggest advantages of these orders is that you don’t need to constantly monitor how your foreign currencies are performing during volatile periods. This is particularly advantageous if you don’t have much time available. This strategy means you can avoid selling currencies which could still produce profits, and you can avoid holding onto currencies that are falling in value for longer than you should.

The biggest disadvantage of a stop loss order is that your order might be executed when a currency experiences a short-term fluctuation in its value before recovering. If you’re not willing to ride a market’s ups and downs, and so choose a stop loss order, you could risk missing out on long-term profits.

Sign up for a business account with Moneycorp

Stop loss orders are particularly helpful for decreasing some of the risks you face when buying and selling foreign exchange. These orders are only one of the strategies we offer. Sign up for a Moneycorp account, explore our various FX solutions and global payment solutions, and take advantage of those that best suit your needs.