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 share exchange. There are a few policies and strategies that you can use to shield yourself from pitfalls in both buying and selling stocks. Here, we will cover “What is Stop Loss in Stock Market” in simple terms and methods to use.
What is Stop Loss in Stock Market
The main aim of setting a 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. We also know stop-loss 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 analysts advise investors to trade always with the stop-loss order.
Advantages of Stop Loss
- 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.
Disadvantages of Stop Loss
- Short-term price fluctuation can trigger SL orders frequently. Wide price fluctuations can also cause a problem.
Types of Stop Loss
The stop-loss system may be of different types or varieties. Basically, the stop-loss market and stop-loss limit. The difference between the two is given below.
Stop-Loss Market Vs Stop-Loss Limit Order
SL Market 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 causes the trader to lose more money than expected.
SL Limit Order
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.
Pros and Cons of a Stop Loss Limit Order
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.
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.
When you place a bracket order, you get an option to either place a fixed stop-loss order or also the 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.
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 by a compulsory Stop Loss order, in a specified range. You can not cancel this Stop Loss Order.
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.
How to Put the Stop Loss in the Stock Market?
Though there are lots of investors who trade with SL, a few of them set the SL price after a proper analysis but the 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 resistance or at the support level are the true utilizer of SL orders.
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, you can decrease the probability of incurring a loss.
A good stop-loss level should be set just below the stock’s support area. This will reliably protect against losses while helping you take advantage of any potential upswings in the market.
To use a stop-loss example, take note of where your stock’s price opened and then decide at what point to place an order that would automatically sell if prices dip too low. Keep in mind your exit strategy before entering into any trade.
Stop loss helps traders protect themselves from incurring large losses or missing out on profits during turbulent markets. It functions by immediately selling positions when certain pre-determined levels are reached, either cutting losses or taking profits depending on the price parameters set by the trader beforehand.
A ‘stop loss’ executes an automatic sale trigger after achieving predetermined market conditions – such as when your price threshold reaches (e.g., the current market rate falls below purchase value). On the other hand, ‘limit orders’ provide instructions to put an entry/exit position only once the price breaches specific limits. This allows investors to set targets for their investments at preset intervals (e.g., they can lock in the maximum gain can above 5%).
Stop Loss is an essential tool for traders trading in the stock market. However, traders need to put correct stop loss prices, or else they will face loss by the unnecessary triggering of the stops. Therefore, it is advised to analyze the market properly prior to setting the SL limit. It not only protects you from incurring great losses but also saves you time from constantly monitoring the stock price in the market.