USING STOP LOSS ORDER TO MANAGE RISK IN CFD TRADING

WHAT IS A STOP-LOSS ORDER?

“The most important rule of trading is to play great defense, not great offense. Every day I assume every position I have is wrong. I know where my stop risk points are going to be.” This is according to Paul Tudor Jones.
Generally, risk management in CFD trading is the process of identifying, analyzing and controlling risk in order to mitigate the negative impact on your trading account.
A stop-loss order, being a key risk management tool is an instruction you give your financial broker to automatically sell (or buy) a security when it reaches a predetermined price, thereby limiting potential losses. It can also be used to lock profits too.
While Contract for Difference (CFD) on the other hand is an agreement between a trader and a broker to exchange the difference in the price of an asset between the opening and closing of a trade.
CFD trading carries higher risk due to leverage and as such, the need for proper risk management can’t be overemphasized. One of the most common and effective ways to manage risk is by setting your stop-loss orders correctly as a trader. How stop loss order can help you manage risk in CFD trading is a function of setting it correctly.
 

THE “90-90-90” RULE VS THE GOLDEN RULE

You must have heard the trading adage that “90 percent of traders lose 90 percent of their capital in the first 90 days”. What then differentiate the other 10%? 
The major reason greater percentage of traders lose in their first three months includes but not limited to: lack of proper education, lack of discipline, lack of risk and money management, emotional trading, not having and sticking to a trading plan and amongst others.
In contrast, the other 10% of traders who succeed starts with education, practice demo trading, proper risk management, stick to their trading plans and are consistent with learning.
The importance of discipline and consistency cannot be overstated, as trading is a skill developed through practice and patience, it's not rocket science.

ESSENTIAL TRADING TIPS IN USING STOP LOSS ORDER

•    Never risk your entire account as a stop-loss: So many traders fall into this trap, they either skip setting a stop-loss entirely or worse, they set it at the level of their entire account.
•    A stop-loss is not a backup plan, it’s a mandatory rule for survival in the markets.
•    Trading without a stop-loss is not strategy but rather gambling.
•    Risking your entire account as a stop-loss? That’s not bold, its financial suicide.
•    Here's what smart traders do: Risk 1-2% of their capital per trade, they define their exit before they enter. Smart traders respect the plan, no emotions nor ego. You can always re-enter the market. But you can't re-enter if you're out of capital. Assumedly, your stop-loss is your seatbelt and your capital is your vehicle so drive safe.

STOP LOSS MISTAKES TO AVOID:

Generally, there are five possible outcomes in trading: big losses, small losses, big wins, small wins and breakeven.
The primary goal of every trader is to mitigate or totally eradicate big losses. When that is achieved, any of the remaining outcomes are acceptable and over time, will contribute to consistent capital growth, the key to becoming a successful trader.
In trying to eliminate the big losses and staying profitable, below are some mistakes that greater percentage of traders make when using stop loss order:
•    Setting an overly tight stop-loss: Setting a stop-loss that’s too tight can backfire, even minor market fluctuations may trigger it, taking you out of a trade prematurely.  Always allow enough room for the trade to breathe when setting your stop-loss.
•    Setting an overly loose stop-loss: Conversely, setting a loosed stop loss defeats the original purpose, hence risking so much of your capital.
•    Not setting one at all: Results in significant losses, the very outcome every trader aims to avoid.
 

How to Calculate a Stop-Loss

Basically, traders use various approaches to calculate stop-loss orders. Here are some common methods:
•    Percentage Method
Example: Risking 2% of your $10,000 account = $200
You size the trade so a loss at your stop = $200 max.
•    Technical Method: Place stop below recent support (for longs) or above resistance (for shorts).
•    Volatility Method: Use tools like ATR (Average True Range) to account for price swings.
 

TYPES OF STOP-LOSS ORDERS

There are several types of stop-loss orders, including:
Fixed stop-loss, trailing stop, percentage-based stop, time-based stop, chart-based stop, and the stop-limit order.
In general:
•    For a buy trade, the stop-loss is placed below the entry price.
•    For a sell trade, it’s set above the entry price.
Stop-loss orders can also be used strategically to lock in profits as a trade moves in your favor.
 

WHY USE A STOP-LOSS ORDER?

Stop loss can help you manage risk in CFD trading in the following ways
•    By Limiting losses automatically
•    It is also commonly used by traders to lock in profits, effectively protecting gains even if the market retraces.
•    The use of stop loss also helps remove emotions from trading decisions
•    It also enforces discipline and risk management
•    Stop loss protect capital, especially in volatile markets and makes you sleep better. You don’t have to watch the market every second
 

PUTTING IT ALL TOGETHER: Risk Management Example (Using Stop-Loss Order)

Imagine the details below represents an individual trading portfolio and he has chosen to follow a key rule of risk management i.e. setting his stop-loss wisely.
•    Trading Capital: $25,000
•    Risk Per Trade: 2% of capital
•    Risk Amount: 2% of $25,000 = $500
•    Pip Risk: 50 pips
•    Trade Setup: Buy EUR/USD at 1.1080
•    Stop-Loss Level: 1.1030 (50 pips below entry)
•    Pip Value for Standard Lot: $10
•    Total Risk in Dollars: 50 pips × $10 = $500
•    Position Size (Trading Volume): $500 ÷ (50 pips × $10) = 1 standard lot (This can be divided to open multiple smaller positions if desired).
If price drops to 1.1030, his broker will automatically close the trade at that level, limiting his loss to $500. Hence his remaining account balance would be $24,500.
This approach not only protects your capital but also helps you stay disciplined and consistent in your trading decisions.
Conclusively, before you execute your next trade on any trading platform, plan your exit before you enter by doing the following:
•    Determine the Risk Percentage: Decide how much of your capital you're willing to risk on a single trade, for example say 2% of $20,000 i.e. $400
•    Identify the Risk in Pips: Know the distance between your entry price and stop-loss e.g., 50 pips.
•    Calculate Position Size (Volume)
Use your account size, risk percentage, and pip risk to calculate the appropriate lot size especially for forex trading.
•    Set Your Stop-Loss Strategically
For a long (buy) position, place your stop-loss below your entry, ideally below a key support zone.
For a short (sell) position, place your stop-loss above your entry, preferably above a resistance level.