Stop Loss Order: Advantages, Types, Risks, Meaning

Stop Loss Order: Advantages, Types, Risks, Meaning

Find Stop Loss Order: It’s easy to overlook certain essential factors when determining whether or not to buy a stock because there are so many to consider. One of those considerations could be the stop-loss order. A stop-loss order, when used correctly, can make a huge impact. And almost everybody can profit from this technology.

What is Stop Loss

A stop order, also known as a stop-loss order, is an order to purchase or sell a stock after its price hits a certain level, known as the stop price. A stop order becomes a market order when the stop price is reached. A purchase stop order is placed at a higher price than the current market price.

Investors typically use a buy-stop order to restrict a loss or protect a profit on a stock they have sold short. A sell stop order is placed at a lower price than the current market price Investors typically use a sell-stop order to minimize a loss or safeguard a profit on their stock.

In another way, A stop-loss order is a purchase or sale order made with a broker when the price of a security reaches a certain level. Stop-loss orders are different from stop-limit orders in that they are designed to limit an investor’s loss on a position in a deposit. When a stock falls below the stop price, the order transforms into a market order, which executes at the best available price.

Example:- Think about it. Assume you purchased a stock at Rs 100 per share. You place an Rs 80 stop-loss order immediately after buying the stock. Your shares will be sold at the current market price if the stock falls below this level (Rs 80). The benefit of a stop-loss order is that you don’t have to keep track of how a stock is performing, and the trade is automatically executed once the stop-loss level is specified.

Understand Stop Loss

Traders or investors can use a stop-loss order to protect their winnings. Since it becomes a market order, it eliminates the possibility of an order not being executed if the stock continues to fall. A stop-limit order is triggered when the price goes below the stop price; however, due to the value of the limit element of the order, the order may not be executed.

The only disadvantage of using a stop-loss is if a stock unexpectedly drops below the stop price. Even if the stock is trading severely below your stop-loss threshold, the order will trigger, and the stock will be sold at the next available price.

When a consumer requests that a broker sell a security if it falls below a set stop price, this is known as a sell stop order. The stop price in a buy stop order is higher than the current market price.

Example:- A trader may, for example, purchase a stock and place a stop-loss order 10% below the purchase price. If the stock falls below a certain level, the stop-loss order will be activated, and the shares will be sold as a market order.

Find Stop Loss Level

  • The 50-day moving average (DMA), 100-day moving average (DMA), and 200-day moving average (DMA) are all useful for determining the stop loss level.
  • The crossover levels of technical indicators like the Relative Strength Index (RSI) and Moving Average Convergence Disconnect (MACD) provide an accurate figure of the breakdown trigger.
  • Trend line support can either be rising or falling and can be used as a stop-loss price.

Type of Stop Loss Order

There are two types of stop-loss order –

  1. Stop-loss Market Order
  2. Stop-loss Limit Order

Stop-loss Market Order- Only Trigger Price

In this case, the Stop-loss Order is converted to a Market Order once the trigger price is met.

Stop-Loss Limit Order- Trigger Price+Limit Price

The Stop-loss Order is converted to a Limit Order when the security price hits the trigger price.

Stop-Loss Limit Order- Trigger Price+Limit Price

In this case, the Stop-loss Order is converted to a Limit Order when the security price hits the trigger price.

Adv. And Dis. of Stop Loss Order

Pros

  • Protects against significant losses.
  • Allows you to have more control over your account.
  • Aids in the management of various transactions.
  • At any time, it is automatically executed.
  • Simple to put into practice.
  • Allows you to choose the amount of danger you’re willing to take.

Cons

  • Trades may close too soon, limiting profit possibility.
  • Traders must choose the rate to set, which might be difficult.
  • Investors must decide on a price, which can be a difficult task. Financial advisors can assist you, but they will not be accessible.
  • Your stockbroker may impose a fee for using a stop-loss order, which will be charged to your brokerage.

Importance of Stop Loss Order

Individuals can efficiently manage their losses using stop-loss orders without closely monitoring the market. It is especially advantageous for risk-averse individuals who want to generate significant profits from stock market investments while limiting their exposure to market fluctuations.

Because the highest or lowest value cannot be predicted in advance, stop-loss trading allows people to quit a position before it reaches its peak. As a result, if an investor retains a place for a long time to earn more enormous profits, a price change can result in significant capital losses.

How Does a Stop Loss Order Work

Consider the following example: Follow these steps if you have a buy position in stock ‘X’ at 100 and want to sell a stop-loss order for stock X at 96.

Sell Stop-Loss-Market order:

The Price of the trigger is 96 rupees

When the Last Traded Price (LTP) reaches 96, a Sell Market order will be placed, and your position will be squared off at the best available bid price.

Sell Stop-Loss-Limit order:

The Price of the trigger is 95 rupees.

We’ll retain the Limit Price at 95 for now. (Remember: Trigger Price => Limit Price for a sell Stop Loss Limit Order.)

A Sell Limit Order is activated when the LTP reaches 96, and your order will be squared off at the next open bid above the limit price of 95. Your Stop Loss Order may be executed at the cost of => 95 in this situation.

 

Note

In the example above, your stop-loss order will not be executed if the current market price goes below 95 and does not cross 95 at any moment during market hours.

Consider the following scenario: you have a sell position in stock ‘X’ at 100 and want to set a stop-loss order at 105.

The trigger price for a purchase Stop loss-Market order is 105. When the market price reaches 105, a Buy Market Order is triggered, and your position is squared off at market price.

Imagine you’ve set the trigger price at 105 and the limit price at 106 for a buy Stop loss Limit order (Trigger Price = Limit Price for a buy Stop loss Limit Order).

As a result, the buy limit order will be activated when the market price reaches 105, and your position will be squared off at the next available ask/offer below 106. In this situation, your Stop Loss order might be filled for 106.

 

Note

In the example above, your trade will remain open if the current market price does not fall below 106 during market hours.

Trailing Stop Loss Order

A Trailing Stop-Loss is an order that allows you to specify a maximum loss amount or percentage on a trade.

If the price of the securities rises or falls in your favor, the trigger price rises or falls in lockstep with it at the specified value or percentage.

Depending on the form of the transaction, the trigger price stays in place if the security price rises or falls against you.
Depending on the nature of the deal, a Trailing Stop Loss Order adjusts the stop price at a predetermined percent or value above or below the stock’s market price.

How Does a Trailing Stop Loss Order Work

Consider the Trailing Stop-Loss of rs.20 for a Buy Position of stock X at rs.100.

A Sell Market Order is sent if the LTP of ‘X’ falls to rs.80, and your position is squared off at market price.
The sell Stop-loss order adjusts to the trigger price of rs.120 if the LTP of ‘X’ increases to rs.140.

How Does a Trailing Stop Loss Order Work
How Does a Trailing Stop Loss Order Work

Consider the Trailing Stop-loss set at rs.20 for a Sell Position of ‘X’ at rs.100.

A Buy Market Order will be executed at the market price if the LTP rises to rs.120.

The Buy Stop-loss order will adjust to the trigger price of rs.100 if the LTP of ‘X’ falls.

What is stop loss?

A stop-loss order is a purchase or sale order made with a broker when the price of a security reaches a certain level. Stop-loss orders are different from stop-limit orders in that they are designed to limit an investor’s loss on a position in a deposit.

What is Trailing stop loss order?

A Trailing Stop-Loss is an order that allows you to specify a maximum loss amount or percentage on a trade.

How does a stop losget triggered?

During a challenging market, a stop-loss order can be a lifesaver. When the stop-loss is achieved, a price level specified at the start of the trade allows traders to close their position automatically. Squaring off happens at the next available price at the trigger price level, which helps to limit losses.

What is the 1% rule of trading?

The 1 % rule establishes the maximum amount of risk taken in a single deal, often known as the risk-per-trade. When the stop-loss is triggered, you must change your position so that your total loss does not exceed 1% of your trade value. The 1% rule can help you prevent significant losses.

 

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