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What is Stop Loss in Stock Market in Simple Terms?

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One and only objective of any kind of investment is making a profit. By avoiding loss, every investor tries to make a highly profitable return. There are many investors who don’t realize what to do to secure themselves in the stock exchange. There are few policies and strategies that you can use to shield yourself from pitfall in both buying and selling stocks. In this content “What is Stop Loss in Stock Market” we will cover stop loss in simple terms and methods to use.

What is Stop Loss in Stock Market

The main aim of setting stop loss while trading is to set the limit of the loss. One and only function of the stop-loss order is to limit the loss. Stop-loss is also referred to as “stop order” whereby the investor instructs the broker to automatically sell or buy a stock if it drops or arises at a certain price. The strategy can be applied in both short-term and long-term trading. In order to avoid loss in trading most of the well-known analyst advice investors to trade always with the stop-loss order.

what is stop loss in stock market

Along with advantage stop-loss order also carry disadvantage. The points are as follows:

  • It avoids the need for constant monitoring of the stock price in the market.
  • Stop-loss is basically protection to save you from excessive losses.
  • It is a buy or sells order which gets triggered automatically by the broker/agent.
  • You can place the stop-loss limit according to your wish.

Besides these, there are also some negative points, such as:

  • Short-term price fluctuation can trigger SL order frequently. Wide price fluctuations can also cause a problem.

Types of Stop Loss

Stop-loss system, may be of different types or and variety. Basically, the stop-loss market and stop-loss limit. The difference between the two is given below.

A Stop-Loss Market Vs Stop-Loss Limit Order

A stop-loss market order triggers if the stock falls to a certain price. Technically, it is a market order. The market order executes at the next price available there. In such a volatile situation, the price at which a trader actually sells could be much lower than anticipated. This cause the trader to lose more money than expected.

Reversely, a limit order trades at a specific price or better. The limit order ensures that the trader does not execute the trade at a lower price than predicted. Limit orders cost more price in trading fees than stop-loss orders. Besides this, limits have a time horizon after which they automatically cancel. This time limitation may cause limits to cancel before they are executed if the price never reaches its trigger point.

A hybrid of the stop-loss order and a limit order is the stop-limit order. This method combines the features of a stop-loss order and a limit order. When the stock reaches a specified price, it triggers the trade as a limit order and trades only at that price or better.

While the investor is better able to control the trade price with a stop-limit order, the downside is that there is no guarantee the trade will transpire. In markets where the price is falling, the market value may drop below the limit price. In this case, buyers will buy in the open market at the lower of the two prices.

Bracket Order

It is a type of order where traders can enter a new position with a target or exit and a stop-loss order. As soon as the main order is executed the system will place two more orders (profit-taking and stop-loss). When one of the two orders (profit-taking or stop-loss) gets executed, the other order will get canceled automatically.

Trailing Stop-loss

When you place a bracket order, you get an option to either place a fixed stop-loss order, or also an ability to trail your stop loss. What this would mean is that if the stock moves in your direction by a particular number of ticks, the stop-loss will go up/down based on if you are long or short automatically.

Cover Order

A Cover Order is an order which is placed along with a compulsory Stop Loss Order. In a Cover Order, the buy/sell order can be a Limit/Market Order and is accompanied with a compulsory Stop Loss order, in a specified range. This Stop Loss Order cannot be canceled.

Since the Stop Loss Order is being placed simultaneously while getting into the contract, the risk that is being taken automatically reduces. Because the risk reduces, the margin requirement also automatically reduces. Remember that all cover orders (CO) will be automatically squared off around 3:20 PM and hence this is a good tool for Intraday traders only.

Points to Remember:

Though there are lots of investors who trade with SL, few of them set the SL price after a proper analyzation but rest of them just put a random figure according to their wish. Those who technically analyze the market movements correctly and set a price near the amount or at the upcoming supporting level are the true utilizer of SL order.

For example, suppose you have bought a stock at Rs. 100 and after analyzing the market, you assume that the support level is at 98, you set the stop loss limit below that point, say at 97. In this way, the probability of incurring loss will be minimized.

Therefore it is advised to analyze the market properly prior to set SL limit. It not only protects you from incurring great loss but also saves your time from constant monitoring the stock price in the market.

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