Stop/loss orders can potentially serve as tools to help traders manage their risk. They are implemented by the trader to automatically sell a long position or buy back a short position once a predetermined price threshold has been crossed.
Below is a chart of the S&P 500 futures contract (ES) showing a break in a trading channel that can potentially be used as a stop/loss level:
Benefits of Stop/Loss Orders for Futures Trading
Stop/loss orders can be used as part of your futures trading strategies for limiting the amount of emotion and pressure associated with active market conditions. These orders can add an unaided element of discipline to your day trading position by keeping your strategy on point. Stop/loss orders can also help lock in potential profits or limit potential losses by exiting a position at a predetermined market price level.
Disadvantages of Stop/Loss Orders for Futures Trading
While stop/loss orders can prevent and limit losses in futures trading, setting them too ‘tight’ or not leaving enough room for your position to ‘run’ may result in missed opportunities. Profits may be unintentionally limited due to setting a stop/loss order that is too close to the current price action.
Build a Trading Strategy Using Stop/Loss Orders
Before entering the market by opening a trading position, the following steps may help with building a strategy using stop/loss orders:
- Analyze historic price action
- Determine potential support and resistance levels
- Use support or resistance levels as day trading indicators to decide on the price level to set a stop/loss order:
- If you are opening a ‘long’ position or buying a financial instrument, determining a potential resistance level may provide guidance to base a stop/loss order on
- If you are opening a ‘short’ position or selling a financial instrument, determining a potential support level may provide guidance to base a stop/loss order on
Always keep in mind that implementing a stop/loss strategy does not assure a beneficial trade or hedge. As with any trading strategy, stop/loss orders involve risk that has to managed. Additionally, a stop/loss order does not guarantee exit from or entry into a position at a specified price.
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