In my 22 years of theoretical experience in the stock market and last 15 years of practical experience in trading I have seen the most important factor in intraday OR short term swing trading is putting a stop loss. So I felt the need to discuss a stop-loss order in details and how exactly to put a correct stop loss trigger price?
The Need Of Stop Loss Order:
As an intraday OR short term trader, once you are in a trade you should keep your losing position limited to stop losing a big amount OR losing almost whole capital. Hence you must put a stop-loss order immediately after the entry. If you have bought a stock you must put a stop order below your buying price and if you have short sold stock you must put a stop order above your selling price.
For example, you can buy a stock at Rs. 100 with a target of Rs. 105 and stop loss of Rs. 98. Similarly, you can short sell a stock at Rs. 100 with a target of 95 and stop loss of Rs. 102. So if you do not get your target your maximum possible loss will be Rs. 2 in both the cases.
Observations On Stop Loss Order:
1) Traders don’t put stop loss at all.
2) Most of the time novice traders put incorrect stop loss trigger price.
An incorrect stop loss trigger price can immediately fetch a loss for you. Many times novice traders put exactly opposite stop orders, i.e they put stop higher to their buy price OR lower to their sell price. This can affect the immediate triggering of the stop orders and thus booking immediate losses for the traders.
How To Put Correct Stop Loss Order?
1) SL should be lower than buy price.
2) SL should be higher than short sell price.
3) There should be an optimum gap between the stop order price and stop-loss trigger price.
Point number 3 is of utmost importance as if there is not enough gap between your stop order price and trigger price the stop order will trigger but the trade will not be executed and this is possible in case of sudden price movements.
Case Study – DRREDDY
Check the difference between bids and asks of a stock. You will get this information from Zerodha Kite.
So you can see the difference between the bid and offer in DR REDDY is around 50 paisa to 1 rupee. If you put a very small gap between the order price and trigger prices like 5 OR 25 paisa your order will be triggered but not executed in times of extreme price movement. See the image below on how to put a correct stop-loss order.
Example Of A Sell Stop Order:
Suppose we have bought DR REDDY. The current market price is 2487. We put stop loss trigger price at 2480 and sell price at 2479. This means that if price breaks 2480 the sell trade will be triggered with a limit order of 2479 and the scrip will be sold nearest available price between 2479 and 2480.
Example Of A Buy Stop Order:
Suppose we have short sold DR REDDY. The current market price is 2487. We put stop loss trigger price at 2491 and buy price at 2492. This means that if price breaks 2491 the buy trade will be triggered with a limit order of 2492 and the scrip will be sold nearest available price between 2491 and 2492.