Stop loss orders are one of the easiest ways to increase your chances of survival when trading commodities and futures. The strange thing is that many traders refuse to use a stop loss strategy – even after they have been burned many times.
Stop losses are a type of futures order that a trader places to limit his losses on any particular futures trade. On futures contracts that a trader buys, he would place a stop loss somewhere below his entry price. For contracts that a trader is short, a stop loss would be placed somewhere above the entry price.
For example, a futures trader buys one contract of gold at $650. He only wants to risk $700 on the trade. Therefore, he would place a sell stop loss order at $643. If gold futures trade at $643, the stop loss order is executed at the current market price. The trader is not guaranteed to get filled at exactly $643, because the stop loss order becomes a market order after the stop price is hit.
Benefits of Using Stop Loss Orders
Any trading plan for trading commodities should include the amount of money you are willing to risk on any given trade. The best way to implement that plan is to place a stop loss order on every position immediately after the order is executed. This will keep you disciplined in controlling your risk and help you stick to your trading plan.
The best part of a stop loss order is that you can place it and not have to second guess yourself on when you will get out of a losing trade. A common mistake among losing traders is that they will sit and watch a bad trade turn into a disastrous trade. It is quite a demoralizing feeling to stare at the quote screen and watch your predetermined loss of $1,000 turn into a $5,000 loss in a matter of days. That can and will happen to traders who do not you stop loss orders.
Why Do Some Traders Refuse to Use Stop Loss Orders?
Some commodities traders are afraid to take a loss. The ego can be a scary thing when you are trading commodities. Some people think they have to be right on every trade, which is impossible if you are a fairly active trader.Sometimes the market will hit your stop loss order and turn around at that very point. Had you not used a stop loss, you would still be in the trade and maybe even showing a profit. I can tell you that happens to everyone, but in the long run you are much better to still use stop loss orders than to suffer huge losses. There are times when commodities move much higher or lower than anyone expected and that one trade can severely cripple your account.
