A stop loss is a trading mechanism designed to limit an investor's loss on a position. When a trader sets a stop loss, they specify a price level at which the position will be automatically closed if the market price moves unfavorably. This tool is commonly used in various markets to mitigate the risk of significant losses by establishing a predefined exit point.
Stop losses can be categorized into two main types: standard and trailing. A standard stop loss remains fixed, triggering a market order once the asset reaches a specific price. In contrast, a trailing stop loss adjusts with the market price, maintaining a certain distance from the highest price achieved. While stop losses can help manage risk, they are not foolproof, especially in volatile markets where price gaps may occur.