Stop loss orders are designed to limit the amount of money that a trade can lose, by exiting the trade if a specific price (that is against the trade) is reached. For example, a trader might enter a long trade at 4,000, and place a stop loss order at 3,950. If the price goes against the trade and reaches 3,950, the stop loss order will be filled, which will exit the trade, thereby limiting the loss to 50 points.
Regardless of what you may be told by supposed professional traders, there is no question about whether stop loss orders should or should not be used (they should always be used if you were in any doubt). However, there is a question as to which type of order (market or limit) stop loss orders should use.
Stop Loss Market Orders
Stop loss market orders are stop loss orders that use stop market orders as their underlying order type. Stop market orders are placed at a specific price, and if the market price reaches the order price, the order will be executed as a market order.
Market orders are always filled, so the stop loss order will also always be filled, and the trade will definitely be exited. However, market orders are filled at the currently available best price (the bid price for a sell order, and the ask price for a buy order), which means that the stop loss could be filled at potentially any price. When a market is moving quickly, a stop loss market order can be filled at a price that is several ticks away from the stop loss price (the price at which the stop loss order is placed).
Stop Loss Limit Orders
Stop loss limit orders are stop loss orders that use stop limit orders as their underlying order type. Stop limit orders are placed at a specific price, and if the market price reaches the order price, the order will be executed as a limit order.
Limit orders are only filled at the order price (or at a better price if one is available), so the stop loss order will only be filled at the stop loss price. However, unlike market orders, limit orders are not always filled, which means that the stop loss order may not get filled, in which case the trade will not be exited. When a market is moving quickly (or if a market has a large bid / ask spread), a stop loss limit order can remain unfilled indefinitely, and the trade is was supposed to protect will remain active.
Which Type of Order Should be Used?
In general, stop loss orders should use stop market orders. The entire point of a stop loss order is to exit a trade, and a stop market order is the only type of order that will always accomplish this. The additional losses that are incurred from adverse fills (i.e. orders that are filled at unfavorable prices), are minimal compared to the potential loss that can arise from a trade that is not exited at all (due to an unfilled stop loss order). In addition, the potential for an adverse order fill, can be offset somewhat by placing stop loss orders at unique prices (i.e. avoiding placing stop loss orders where everybody else does).
I say in general, because there are some situations where a stop loss limit order can be used, such as a trailing stop where the stop loss price is already significantly in profit, or a stop loss order that is not being used as an emergency stop loss (i.e. a crash stop loss). However, regardless of the configuration of a trade's stop loss orders, every trade should use a stop loss market order that will exit the trade completely.