Stop orders, commonly called stops or stop losses, are a very important part of a trading plan for commodity futures traders. Stop orders are placed on the opposite side of what is commonly considered normal to new commodity traders.
Buy stops are placed above the current market price. For example:
- You are short March soybean futures at $8.50. You want to risk 10 cents on the trade or $500 (5,000 bushel contract x .10 = $500). You would place a buy stop order at $8.60 to limit your losses to 10 cents on the trade.
- You are long June gold futures at $700 an ounce. You want to limit your losses to $10 an ounce or $1,000 (100 ounce contract x $10 = $1,000). You would place a sell stop at $690 to limit your losses to $1,000.
Stop order are placed for two reasons:
- To limit your losses if the market moves against your position. It is a good practice to place your stop orders right after you get into a new position. After a trade has moved in your favor, stops can also be used to lock in profits.
- Stops can be used to initiate positions. They are placed above or below the market price and bought or sold on momentum. Trend followers like to use stop orders to initiate positions when a market breaks above or below resistance; or a market breaks to new highs or lows.
There is no guarantee that your stop order will be executed at your specified price. The stop order is triggered once it hits your order price and it is then executed at the market price. Usually, stop orders are filled at a little worse price than your order price. Sometimes fills can be drastically worse if the markets are moving quickly against you or the market gaps against you when it opens.
Stop orders are an essential part of trading for successful traders as a means of cutting losses short and using good money management practices. You may not like getting bad fills once in a while or the market hitting your stop order and turning right around, but you will come out much better in the long run by using them diligently.