If, for example, you’ve bought a market with the expectation that it may go up, you would place a contingent stop order, linked to the long position below the current market price. If the price falls below that price, the open-long position would automatically be closed.
If you bought the GBPUSD Forex rate at 1.3000 (with an expectation for it to go higher), but it went lower, you could set a stop loss at 1.2900. If the market went lower and hit 1.2900, the stop would be triggered, and the long GBPUSD position would be closed automatically, with a loss of 100 pips (0.1000), and the actual loss multiplied by the position size.
Conversely, if you had a bearish view on Gold, and sold at 1600.00 with a view for a fall in the price, you might want to protect the amount you could lose by placing a stop order above the current market, for example at 1640.00. If the market went against you and pushed up above 1640.00, the short position would be automatically exited for a loss of 40.00 (again, multiplied by the position size).
It’s worth noting that when a stop is triggered, it does NOT necessarily have to result in a loss – not all stops are stop losses. Stops can be used to manage open positions when the market has moved in your expected direction so that the open position stays in profit.
Let’s return to the long position discussed above, buying the GBPUSD Forex rate at 1.3000.