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Stop-Loss: What It Is, How It Works & Different Types

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 Investing in cryptocurrencies and equities is becoming increasingly popular, especially among younger generations. This is likely because of the ease of trading digital assets and the market’s decentralization.

Nevertheless, despite the convenience and high-profit potential, it is crucial to remember that the cryptocurrency market is highly volatile. Therefore, investors should exercise caution.

In reality, a variety of tools exist to mitigate investment losses. Among these strategies is stop-loss order.

In this article, you will learn more about stop-loss orders, their uses, types, when to use them, and why they are important for cryptocurrency investors.

What exactly is Stop-Loss?

The short answer is the automatic sale of an asset when its market price reaches a predetermined threshold.

A stop-loss or stop-loss order is the automatic sale of assets when the market price is predetermined. Users specify the price at which a stop-loss is triggered.

Stop-loss orders are designed to mitigate losses if an asset’s price fails to rise as anticipated or, more importantly, falls precipitously.

Read Also: What is a bear Market?| How to make profit investing in it.

Pixabay user standret

Several cryptocurrency exchanges offer this functionality. Experienced traders and investors typically place a stop-loss order when purchasing an asset.

An example of stop-loss

Rosie purchased 1 Bitcoin for $41,000 (BTC).

Rosie then places a stop-loss order 10% ($4,100) below the buy price. Therefore, whenever her bitcoin is worth $36,900, the system will promptly sell her holdings.

Therefore, even if the price of Bitcoin falls by more than 20%, Rosie will only lose 10% of her investment.

The functions of stop-loss orders

As Rosie’s experience demonstrates, stop-loss orders can be advantageous for traders. Now that we understand why stop-losses are useful, let’s examine the three most important tasks they can perform.

Making a profit

A trader or investor could earn from this method while waiting for the red candlestick to transform into a green one.

However, the profits will be quite modest.

See More: What are candlesticks in cryptocurrency charts and what do they mean?

Maintaining investments

With this method, investors or traders can keep the value of their investments by selling them when the market price falls below the purchase price.

Avoiding massive losses

This is a way for a trader or investor to avoid losing huge amounts of money when the price of an asset drops.

When to employ stop-loss

Traders utilize limit orders to maximize profits from current trends, whereas stop-loss orders mitigate losses.

Stop-loss orders are used to strengthen investors’ control over future trading-related risk factors. Thus, the optimal time to deploy it would be now, i.e., when purchasing a volatile asset.

Different types of stop-loss orders

There are three distinct types of stop-loss orders to consider. Learn what they are, how they function, and when to utilize them by reading on.

Full stop-loss

In a full stop-loss order, the exchange will liquidate all of the asset’s units when its price reaches a certain level.

Traders or investors often use this method in a stable market with much price volatility since moderate price drops are expected.

pixabay user upkylak

Partial stop-loss

When a trader’s or investor’s assets reach a certain value, a partial stop-loss order tells the exchange to sell only a portion of them.

This method is usually used with risky investments like cryptocurrencies to ensure the investor keeps some of the assets in case the price recovers and soars again.

However, there is no assurance that the asset’s price will return to normal or whether it will continue to decline. Consequently, the trader can still incur a loss.

Therefore, traders who wish to utilize this sort of stop-loss must be aware of its high risk.

Trailing stop-loss

In the first two, dealers tell an exchange exactly when it should sell the asset.

However, trailing stop-loss orders do not have a single liquidation price. In actuality, the point rises with the price of an asset but does not fall.

Tumisu via Pixabay.

When the price of an asset increases, the stop-loss order will follow suit. Users must calculate the trailing distance, which is the gap between the current asset price and the stop-loss amount.

Example

Sally purchases the NEAR Protocol (NEAR) for $30 and specifies a $0.05 trailing distance. Therefore, her stop-loss order is set at $29.90.

Sally’s stop-loss order will automatically adjust to the US $34.90 if the NEAR price rises to the US $35. However, even if the price drops to $30, her order will remain at $34.90.

The dynamic adjustment of the stop-loss order enables investors to preserve the upside potential of transactions while minimizing losses. Consequently, it is also known as a “protect stop.”

Why is the stop-loss order so important?

The purpose of stop-loss orders is to mitigate losses caused by market movements. As you may be aware, market trend variations can result in the loss of assets or even a substantial amount of money.

No matter what kind of stop-loss order a trader or investor uses, they must consider the risk and possible reward.

Stop-loss orders are merely a trading technique. Whether or not an order works depends on how well a trader understands the market.

Reference

zipmex.com

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