What is a stop-loss order?

A stop-loss order could help you avoid big losses on your currency investments.

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The exchange rate between a currency pair can change suddenly. These fluctuations could transform a good investment into a poor one — and quickly too.

To avoid losing too much on your investments, especially in volatile markets, consider a stop-loss order.

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What is a stop-loss order?

A stop-loss order is a “hedging” tool. When you place a stop-loss order, you set a minimum exchange rate at which you would want your transfer to be carried out. If the exchange rate decreases and hits this minimum, the transaction will be executed.

For example, if you currently hold the GBP/USD currency pair and the price is GBP/USD = 1.22 (meaning £1 buys 1.22 USD), you might put in a stop-loss order to sell at GBP/USD = 1.20. This means that once the exchange rate hits 1 GBP = 1.20 USD, your brokerage will automatically sell your holding.

What is hedging?

The investment community uses “hedging” to describe protecting or lowering your risk of loss on a trade. There are a few tools you can use to hedge your risk in the foreign exchange and currency transfer market.

Why is a stop-loss order useful?

A stop-loss order is used to limit your losses. If you buy a currency holding and place a stop-loss order 5% below the price at which you made the purchase, then the most you can lose on your investment is 5%.

Joe sends money to the USA

Joe’s daughter is studying in America, and he needs to send over £3000 to cover living costs for next semester. The money doesn’t need to be transferred for another few months, but Joe worries that the pound may steeply decrease in value before then.

The mid-market rate is at 1.24 USD per pound, so Joe sets a stop-loss order for an exchange rate of 1.21, ensuring that his daughter receives at least $3630.

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GBP 2,500 1 day GBP 0.00 1.124 EUR
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GBP 5,000 Same day GBP 0.00 1.124 EUR
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GBP 2,500 Same day GBP 0.00 1.124 EUR
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GBP 5,000 1 day GBP 0.00 1.129 EUR
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Disclaimer: Exchange rates change often. Confirm the total cost with the provider before transferring money.

Are there any drawbacks?

Though the stop-loss order is nice in theory, in practice it doesn’t always work perfectly. Your stop-loss order could be triggered at a certain price, but you may not actually get that price — instead, your order will be fulfilled at the next available price. That’s because when you’re trading currency, there needs to be someone else trading with you.

In fast-moving markets, the next available price means that you may end up losing more than you originally thought you would.

What else should I know?

Some traders recommend that instead of setting stop-loss orders, you should set up price alerts. This way you can decide for yourself what to do next, rather than trigger buying or selling your currency automatically.

Explore other risk management options

If you’re unsure whether a stop-loss order fits your needs, there are other hedging solutions worth exploring:

A popular tactic is to have a limit order and a stop-loss order on the same transaction. If you’re unsure what way the market will go, this is a good way to open yourself up to beneficial fluctuations, while restricting your potential losses. This is often referred to as a one-cancels-the-other order (OCO), as the execution of one order causes the cancellation of the other.

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