What is a Stop-Loss Strategy & How do you use It?
If you wish to invest in the stock market, you must be well equipped with the highs and lows it brings along. Surely you will gain a lot. But you should even be ready to face losses. However, nobody wishes to lose money while trading in the stock markets. Hence, it’s important to understand how to save yourself when you are certain about losing.
Stop-loss in the stock market is one feature that every investor should be aware of.
While stop-loss order is an essential element in stock market trading, it is much more important to set it right. If you end up setting your stop-loss strategy too close, you can get out of a trading position too soon. However, if you set them too far, it may result in big losses if the market moves in the opposite direction. So, how does stop-loss work? Let’s find out below.
What is Stop-Loss in the Stock Market?
The stop-loss order is a strategy placed with a stockbroker to sell or buy a specific share in the market when the price reaches a certain point. Simply put, a stop-loss in the stock market is designed to limit the loss of an investor on a security position. For instance, putting a stop-loss for 10% below the price of the stock at which you had initially bought the stock will limit the loss incurred to 10%.
But, how is this different from stop-limit orders?
You must have also heard of stop-limit orders. So, how does stop-limit work? Stop-limits are similar to the stop-loss orders in the stock market. However, the former limits the share price where the market executes the stop-loss order. So, there are two share prices specified: the limit price and the stop price, which will change the order to a selling order. So, instead of it becoming a market order to sell, the selling order becomes the stop-limit order that will only be executed at the stock limit price.
Benefits of Stop-Loss Order in the Stock Market
The most important advantage of a stop-loss strategy is that you will need no extra fee to implement the same. You will only have to pay a regular commission when the stop-loss order price reaches its threshold, and you will need to sell the stock. So, you can think of the stop-loss order as a free insurance plan.
Another benefit of a stop-loss strategy is that it will allow you to make decisions without emotional effects. A lot of people fall in love with the stocks they invest in. For example, if you start maintaining the false belief that you need to give your stock another chance to make it come around, you will lose out on more funds! In reality, you should be well aware of how and where to put a stop-loss order to avoid further losses.
How Do You Use Stop-Loss Order?
You can use stop-loss to limit your losses in the stock market. It will act as an automatic order you give to your stockbroker to sell a stock before it reaches the predetermined price level. For instance, suppose you buy 50 shares of Nykaa at a rate of ₹1000 per share. You will further wish to limit your losses, and so, you may put the stop-loss order at 10%. So, if the share price goes below that limit, your broker will sell off the shares to prevent further losses.
Now, if the share price goes up to around ₹1400 per share, you would wish to hold on to your shares and not lose your profit. Here, if you put a stop-loss order on selling the shares, if the value drops to ₹1300, you will be able to hold on to your shares and won’t lose the benefits. Therefore, you can protect your investments with the stop-loss order by retaining your gains and preventing further losses.
Things to Consider While Implementing Stop-Loss Orders
As a stock market investor, here are a few things that you will have to keep in mind while implementing stop-loss strategies:
- If you are an active investor, a stop-loss order might not work for you.
- A stop-loss strategy will not work well for large stocks as they might lose more in the future.
- Your stockbroker will charge a different fee for different stop-loss orders. Hence, you need to be aware of how much you are paying them.
- It would help if you always waited for the stop-loss order confirmation. Never assume that it has gone through.
Investors should evaluate all the risks before determining stop-loss order placements. If you are a beginner, you need to be well aware of the market trends to gauge the strategies better. Also, it would help if you remembered that although stop-loss in the stock market is a form of risk management, it will never guarantee profitability.
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Frequently Asked Questions
Above the market’ refers to a market order to purchase or sell a stock at a price higher than the current stock market value.
The lowest possible price is where a security trading designation is instructed to a stockbroker to execute a purchase order for the minimum amount that is possible.
The trailing stop-loss strategy is the one that moves with the security to the investor’s profit. Instead of a set stop-loss value, a trailing stop-loss’s price is usually in relation to the security.
You'll have to start the process by selecting ‘buy’ or ‘sell.’ Next, you will find slight alterations between stockbrokers, but your stop-loss order ticket may have defaulted to a ‘market’ order type. Then you will have to find the place where it says ‘market,’ and then change that to ‘Stop.’ Finally, you will have to pick your stop price and place the stop-loss order.