Source | Stop loss benefits in crypto options trading
In the volatile world of crypto options trading, managing risk is perhaps the first (and many would say – only) rule to follow. In that context, stop loss orders are a neat automation to help traders execute trades based on their risk to reward ratio and protect their investments. In this blog, let’s understand the meaning of stop loss orders and learn how they can benefit you.
Firstly – What is a Stop Loss Order in Crypto?
Stop loss orders are a risk management tool used in cryptocurrency trading. They are placed with a crypto exchange or trading platform which instructs the platform to automatically sell a crypto token when it reaches a certain price, also called the “stop price.” The goal is to limit losses on a position.
Simply put, traders set a stop loss order after opening a trade to define the maximum loss they are willing to accept. Before we discuss how a stop loss order works, we have to understand what do entry price, stop loss price and market price mean.
Understanding Entry Price, Stop Loss Price and Market Price
Entry Price
- The price at which you purchase the crypto is the entry price.
- It acts as a benchmark against which you can measure price movements.
Stop Loss Price
- This is a predetermined price set to limit potential losses.
- For a long position (where you expect prices to rise), the stop loss price is usually below your entry price. If the market price of the cryptocurrency falls to or below this level, your stop loss order will be triggered, and your cryptocurrency will be automatically sold at the best market price.
- For a short position, the stop loss price would typically be set above your entry price.
Market Price
- This is the current price at which a cryptocurrency is being bought and sold on the market.
- It fluctuates constantly based on supply and demand.
How Does Stop Loss Order Work?
- Set the Stop Price: When you buy a cryptocurrency, you enter the market at a specific price. As discussed, this is the entry price. A stop loss order allows you to set a lower price point. If the price of the cryptocurrency drops to or below this lower price, your stop loss order will trigger, and your cryptocurrency will be automatically sold.
- Triggering: When the market price reaches or falls below the stop price, your stop loss order becomes active.
- Execution: Once triggered, your stop loss order is typically executed as a market order. This means your cryptocurrency will be sold at the best available price in the market at the time of execution.
Example:
Let’s say you buy 1 Bitcoin at $30,000. You want to protect yourself from a price drop, so you set a stop loss order at $25,000. If the price of Bitcoin falls to $25,000 or below, your stop loss order will be triggered, and your Bitcoin will be automatically sold at the best available price.
Types of Stop Loss Orders in Crypto
Standard Stop Loss Order
- When the asset’s price hits the stop price, the stop loss order converts into a market order and is executed at the next available price. The actual execution price might be different from the stop price, depending on market conditions and liquidity.
- Example: If you own a cryptocurrency currently trading at $50 and set a stop loss order at $45, the order will trigger a sale if the price drops to $45 or lower. The actual selling price could be $45 or slightly below, depending on how quickly the market moves.
Stop Limit Order
- When the stop price is reached, a stop limit order becomes a limit order rather than a market order. This means the order will only be executed at the limit price or better. The limit price is the minimum price at which you are willing to sell (for a sell order) or the maximum price at which you are willing to buy (for a buy order).
- Example: If you set a stop price of $45 and a limit price of $44 for a sell order, the order will convert to a limit order at $44 once the stop price is hit. The order will only execute if the price is $44 or higher. If the price drops too quickly and falls below $44, the order may not be filled.
Trailing Stop Loss Order
- A trailing stop loss order adjusts automatically as the asset’s price moves in a favorable direction. The stop price is set at a specific percentage or dollar amount below the highest price reached since the order was placed.
- Example: If you set a trailing stop loss with a 10% trailing amount and the asset’s price rises to $60, the stop price will adjust to $54 (10% below $60). If the price then falls, the stop price remains at $54 and will only trigger a sell if the asset’s price drops to $54 or lower.
Stop Loss Benefits
- Loss Limitation: Stop loss orders help limit losses by automatically exiting an asset if its price hits a certain level.
- Protection Against Volatility: Crypto market is infamous for its volatility where prices can swing dramatically. Stop loss orders provide a safeguard against unexpected large losses.
- Automation: By automating the exit process, stop loss orders help traders avoid the emotional stress and indecision that can occur during market fluctuations.
- Predefined Strategy: Traders can set stop loss levels based on their risk tolerance and trading strategy, leading to more disciplined and consistent trading.
- Locking in Profits: Stop loss orders can be used to protect gains by setting a stop price sufficiently far from the purchase price, ensuring that profits are secured even if the market reverses.
- Less Active Management: Traders don’t need to constantly monitor their positions. Once a stop loss order is set, it will execute automatically when the stop price is reached.
Limitations of Stop Loss Orders in Crypto
- Slippage: In fast-moving markets, the execution price of a stop loss order may differ from the stop price, resulting in slippage. This can affect the actual loss or gain realized.
- Order Not Always Filled: For stop-limit orders, there is no guarantee that the order will be filled if the asset’s price moves quickly through the stop price without reaching the limit price.
The Bottomline on Stop Loss Orders in Crypto
Whether you’re looking to limit losses, lock in gains, or reduce the need for constant monitoring, incorporating stop loss orders into your crypto options trading plan can be highly beneficial.
If you want to begin crypto trading but don’t know where to start, consider Delta Exchange India. Delta India is one of the fastest growing platforms in India for crypto derivatives trading. The platform is compliant with FIU (Financial Intelligence Unit) and has an easy to use interface, making it suitable for both beginners and experienced crypto traders.
Whether you’re just starting in crypto trading or looking to hone your crypto trading skills, Delta Exchange is the perfect choice for cryptocurrency trading in India.