Stop loss orders stop losses, right?

Another fond illusion, I'm afraid.

Brokers make a sizeable proportion of their fees, sometimes approaching 50%, from stop-loss orders. No wonder then that many brokers will solemnly warn you that you are irresponsible if you do not always have a stop loss order in place for each and every position that you take. In many cases they will actually require it.

At first sight it seems sensible, but look again.

Unscrupulous brokers will encourage you to place your stop close to your original price, virtually guaranteeing that it will be triggered, thus churning your account at your expense.

If you place your stop a long way from the original price that you paid for the contract, there's hardly any point in placing it - all it may protect you from is a collision with an asteroid belt.  

And if you place it too close, you'll get "stopped out" only to see the market move back in your favour. Remember, markets constantly 'vibrate' up and down. It's really a lose-lose situation that benefits only the broker. And in a major crash (invariably followed by a rebound) your stop loss order will be executed a long way from its trigger price, amplifying your loss.

What to do? There's really no alternative but to decide from the start of your campaign at what price level you will abandon your overall, long-term position, and grit your teeth as the market moves against you in the short term. Be prepared for huge swings, calculating how much you can afford to lose, and consequently work out how much money you need to put at risk - a lot more than you think, when you work it out.

So yes, you need to have a stop loss order in place, but it needs to be a long, long way from your original position and its triggering should mark the end of your campaign. If you do it right, it will almost certainly never be triggered, to the chagrin of your broker and to your enrichment.

But then again there's always that asteroid belt.


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