Orders can be an effective tool to help you better manage your risk and should always be considered as part of your overall trading strategy. While orders can have a critical role in helping you to achieve your trading goals they cannot necessarily limit your losses.
Let’s take a look at some of the most common orders used to manage risk.
Limit orders are primarily used to enter into positions and protect profits. Being in a winning position is probably one of the most fulfilling feelings there is in trading; you are more comfortable when things are reasonable. Why in the world would you ever want to end that feeling? Markets rarely move in one direction for long periods of time; so it’s important that you determine a point with which to take your hard-earned gains before you place the trade.
Stop orders are probably the most popular order type used to limit losses and manage downside risk.
Our minds can play some nasty tricks on us when we are under pressure, particularly when money is on the line. If you enter into a position without a stop order, you are opening yourself up to the psychological effects of the “just one more” paradox.
Trailing stops allow you to guard against your profits while at the same time limit downside risk.
So maybe you’re having a hard time simply taking profit at a particular point; maybe you want to keep pushing the envelope to see where you can take your trade but at the same time you want to limit your losses. In this type of scenario, you may want to consider a trailing stop. A trailing stop dynamically protects your profits on the upside and attempts to protect your losses on the downside.
Unlike a limit or stop order, a trailing stop allows you to specify the number of pips from the current rate, as opposed to the rate at which to trigger a market order. The number of pips automatically trails your order as the market moves in your favor. If the market moves against you, then a market order is triggered and the trade is executed at the next available rate depending on liquidity.