Understanding stop loss orders requires understanding exactly what a stop order is. In short, it is an order you place with your broker telling him to buy or sell a commodity, stock, spread or currency pair once the price has reached a certain level. A stop order can be placed above the current price if you are looking to buy or below the current price if you are looking to sell. It is usually placed to close a position and is often thought of as a stop loss order. In this article, we will clarify this rough definition of a stop order and explain why it is important to use them when trading the Forex markets.

In understanding stop order, it is very important to understand what a market order is. A market order is simply an order one gives his or her broker telling the broker to buy or sell at the best price possible. It is placed with a certain value attached. For instance, if you had previously bought one EUR/USD contract which is trading at 1.3100 and you want to exit this contract should this trade start to turn against you, you may place a stop order at 1.3000. This would tell your broker you would like to exit the trade at 1.3000.

If the EUR/USD should trade at 1.3000 your order will become a market order and the broker will sell your contract for the best price he can get for you. This is important because it illustrates a stop order is not always filled at the exact number you place it for. This type of order simply tells the broker you now want to get out of the trade as soon as possible. So, it is quite different from a limit order which tells the broker you will sell for not a penny less than a particular price or buy for not a penny more than a particular price.

Stop orders are important because they help you set your risk for any trade in advance. The alternative is to let your trade ride for a few days and then come back and find that it is costing you thousands and thousands of dollars! It is for this very reason all but the very best financed Forex traders should take advantage of their opportunity to use stop loss orders.

In the illustration above, the order was placed to prevent the price from falling very far on a currency pair you have bought. However, just as important is the fact you can place one above the price of a currency pair you have sold, or in trading parlance, have shorted. When you are short a currency pair you do not want it rising very much or it will cost you money. Therefore, using the numbers from the example above, if you were short one EUR/USD pair you will probably place your stop order somewhere around 1.3200.

In any event, you should not start trading the Forex market unless you have a very good understanding of the stop order and you resolve you will use it wisely because doing so will help prevent losing your whole account in one shot.