Know What is Stop Loss in Share Market & How to Use it | Espresso

Stop Loss in Stock Market & Its Use

Stop-loss in the stock market helps to limit the loss in a trade. In other words, it is an order to sell the stock or any security when it hits a particular price. When an investor places a stop loss, he or she instructs the broker to sell the stock when it reaches a pre-defined price limit.

 

Published on 12 January 2022

For instance, if Ayush wants to buy the shares of a particular company at a certain price point, he will order his broker to fix the limit against the stock purchase. As the share price reaches the pre-determined bid price, the order to buy the share is executed automatically.

Similarly, if you are the owner of the company’s shares and want to sell them, you would instruct your broker to sell them as soon as the price hits the high or low you have decided. When the price range matches the set limits, an automatic order will get triggered.

Advantages of the Stop-Loss Order

A vital benefit of a stop-loss order is that its implementation is free. You pay the regular commission only after the stop-loss price is hit and the stock must be sold. Another benefit is that it does not let your emotions influence decision-making. The investor does not have any time to fall in love with the stock.

The benefits of a stop-loss orderwill also depend on what kind of investor you are in the stock market. You should know why you buy a stock. The criteria for a value investor will be different from that of a growth investor and also from that of an active trader. An investor’s strategy is successful only if the investor sticks to it. Consequently,stop-loss orders; are not meant for you if you are a rigid buy-and-hold investor.
Also Read: Steps to Invest in Share Market

What are the Different Stop-Loss Order Types?

Broadly, there are two types of stop-loss orders:

  • Fixed stop-loss order

    A stop-loss order executed when the set price is hit is known as a fixed stop-loss order. The investor can also place a fixed stop loss in the stock market based on time. It is commonly used till the trade is placed.

    Time-based fixed stops are the right choice for investors who wish to give the order a fixed length of time to profit before shifting to the next trade. It is best to use time-based stops when positions are properly sized to allow for major unfavourable swings in the stock price.
    Also Read: Swing Trading Strategies

  • Trailing stop-loss order

    A trailing order gives the investor capital gains protection. Moreover, it provides a hedge against any unanticipated price dips. The investor sets a percentage of the total asset price. When the market prices go below the pre-determined level, the order to sell triggers. But, if the price increases, the trailing stop-loss order automatically adjusts according to the overall increase in market valuation.

    Let us understand this with the help of an example. In a trailing stop-loss order, the price is set to trigger if the stock price goes below 10% of the market value. The buying price of the stock is ₹100. The authorized stockbroker automatically executes the order to sell the share if the price goes under ₹90.

    On the contrary, if the stock price rises to ₹120, the stop-loss order is set at 10% of the prevailing market price, ₹108. Thus, if there is a consequent dip in the price after it peaks to ₹120, the authorized broker will execute the trailing stop-loss order at ₹108. The investor can use the trailing stop-loss order to earn a capital gain of ₹8 (108-100) on his investment corpus.

Final thoughts

A stop-loss order is a tool used for short-term investment planning. An investor who doesn’t want to spend time monitoring the portfolio and the movements in the stock market can benefit from the same. The trade is automatically triggered, and the limits are pre-determined. Having a stop-loss strategy is very helpful for small investors.

 

Chandresh Khona
Team Espresso

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