Stop losses are designed to limit losses by executing a market order once the price reaches a certain level. For most traders, this level is usually below their planned entry point or above their planned exit point. In theory, when placed at appropriate levels, stop losses are designed to cut your loss short or help you with locking in a profit. But do scalpers also use stop loss?
Scalpers do use stop losses occasionally. However, implementing stop losses into a scalping strategy is not always easy. With the high frequency nature of scalp trading, managing stop loss to control exposure is difficult. More importantly, profit locking is almost always hard to achieve through stop losses when scalping.
In this article, we explore where and when scalpers use stop-loss orders, why they don’t set them to lock in profits, and the dangers of doing so. Additionally, we will also discuss several alternatives for you to consider if you are just getting started with trading, or looking to further refine your existing trading strategy.
How Scalpers Use Stop Loss?
When scalping, it is extremely easy to get stopped out on positions before the price moves against them significantly. These transactions take place within a fraction of a second using high-speed trading programs that access liquidity from global markets across multiple asset classes, including:
- Commodities, etc.
That being said, scalpers do use stop loss orders in some cases.
If a scalper gets stopped out on their trades by reaching their pre-set stop loss level for whatever reason – bad timing, unknown news release, poor market conditions, etc. – they’ll experience losses. However, with a stop loss order being deployed, these losses would be within the thresholds determined by the trader. Hence, using stop loss orders prevents scalpers from experiencing indigestible losses should the market move against their position.
Furthermore, when you’re running a stop-loss order manually, it’s much easier to monitor the markets. This way, you can move your stop or cancel your position altogether when needed. You could also re-enter your position for fresh profits. That’s because you’re using lower-frequency trading systems that execute trades at set time intervals rather than at pre-set thresholds.
Stop-Loss Manages Risk for Scalpers
We’ve already established that scalpers use stop losses so that they get stopped out before their position moves against them by large amounts. However, this situation by itself doesn’t encourage scalping strategies in general since getting stopped out is normal when using any system to manage risk.
Scalping means executing a high volume of trades at a very fast speed and with a very small size, usually over short periods of time. Being a successful scalper requires a lot of discipline because there’s no room for emotions or mistakes.
The majority of traders who try scalping won’t last long due to the stress involved and lack of patience required. But if you can execute it successfully, scalping provides plenty of opportunities for making money in the financial markets in almost any time frame.
Stop-loss orders, when executed, lock in the price you bought your assets for or the price you sold them at. Scalp strategies execute countless trades during active trading hours; therefore, locking in prices means locking in losses. That makes it impossible to actively trade and keep profits on a consistent basis.
The primary reason why scalpers use stop-loss orders is to keep themselves in the game long enough to benefit from their winning trades outweighing their losing ones. Even if that means taking small losses on some of their trades, it’s better than quitting before the game is over.
Alternatives to Stop-Loss Orders
There are actually several alternatives to using stop-loss orders where you place your exits at predetermined price levels. Alternatives most commonly include laddering and trailing stops.
When you trade with a stop-loss order, you must be in control of your emotions. You need to determine the appropriate amount of risk for your account size, time frame, and personality profile. Using an efficient stop-loss strategy can prevent emotional mistakes that result from greed, fear, or lack of preparation when trading without one.
Laddering – A Modified Stop-Loss Order
Laddering is a technique used by traders to hedge risks when attempting to make a profit from small price fluctuations. It can be used in place of traditional stop-loss orders and is often coupled with short selling. In this scenario, investors purchase shares at three different times but sell them at three different prices.
The first share they buy might be a long position with a target goal of turning a profit in the near future. The second share they buy has an expected lower price than the first purchase’s market value, placing it into the “loss zone.” If the stock price decreases after the initial purchase and enters this, then it will be sold at the second purchase’s price.
The third purchase has an expected higher price than the first, placing it into the “profit zone.” If it increases in value after being bought and enters this, it will be sold at this price. Of course, if the stock decreases in value so much that it falls out of all three zones, all shares bought earlier would be sold at a loss. And vice versa, if the stock value goes up so much that they fall out of all three zones, then all shares bought earlier will be sold for a profit.
It involves placing your stops progressively further away (typically 1-3 pips) as price moves in your favor by predetermined amounts until you reach either predetermined target levels or an appropriate risk/reward ratio. This method requires constant re-calculation and won’t be as effective as a stop order if the price moves quickly.
This method entails moving your stops at predetermined levels in the direction of price movement until you reach either predetermined levels or an appropriate risk/reward ratio. However, there’s no guarantee of winning trades because you use stops, not price levels.
A trailing stop-loss order is a conditional trade order which becomes a market order when the best bid at the time of entry is equal to or less than the specified price. It can be used to help purchase stocks that are temporarily undervalued, but it should only be implemented if you have other orders in place for protection.
How Do Stop-Loss Orders Affect Scalpers?
Stop-loss orders discourage scalping strategies because small losses add up. Using stops is like buying insurance on every trade; there will be times where you don’t need them and times where you do, which is pretty much impossible to predict accurately.
The time and effort required to constantly monitor the markets to move stop-loss orders reduce scalping efficiency. Also, when using a stop loss, you usually lock in small losses when market conditions aren’t in your favor.
Stop-Loss Orders Educate Scalpers
A solid understanding of how individual instruments move in relation to one another can help scalpers manage their risks more efficiently. That’s because it allows them to use tighter stops when needed.
The drawback here is that scalpers need additional research before putting these strategies into practice. However, since scalping deals with very high volumes over short periods of time, it doesn’t require a lot of time to learn such patterns.
The bottom line is that stop-loss orders provide the most efficient exit strategy for all market conditions and can be used by scalpers as well. The amount of extra research required will vary depending on your level of experience; however, stop losses definitely have some positive effects on a scalper’s strategies.
Using stop-loss orders when scalping is highly effective for minimizing risk, maximizing return on investment, and reducing stress caused by prolonged market conditions. Scalpers do use stop-loss orders, but they don’t use them in the way that they were intended.
Stop losses are designed to help traders lock in a profit automatically and ensure their account is properly balanced so it does not go into debt. A solid understanding of how individual instruments move in relation to one another can help scalpers manage their risks more efficiently by allowing them to use tighter stops when needed.