Stop-Loss Orders: The Way To Limit Losses And Reduce Risk

When an investor purchases a stock, he or she anticipates the price to climb to a certain level. However, short-term market changes may cause prices to deviate from expectations. A Stop-Loss Order protects an investor from extreme price volatility by allowing him or her to order the broker to sell the stock at a predetermined price. This price is typically lower than the price at which the stock is purchased.

Meaning Of Stop-Loss Orders

Stop-loss orders are also known as stop orders and stop-market orders. It is a sell order put in advance for an asset to be sold when it reaches a certain price. It is primarily used to decrease or minimize a trade’s loss. Frequently employed in short-term trading. In this automatic order, the investor contacts the broker or agent and pays a commission to make the order.

Variants Of Stop Loss In Share Market

Stop-Loss Order is used in reduction of trading losses. There are several stop-loss order variations, each with a particular purpose.

1. Sell Stop Order:

This order is designed to limit losses or safeguard gains in the event that a stock’s price drops. It employs a stop price that is lower than the current market price.

2. Buy Stop Order:

This order is used to purchase stocks as insurance against losses and to safeguard profits from a short sale transaction. In this case, the stop price is higher than the current market price.

3. Trailing Sell Stop Order:

The stop parameter of a trailing sell stop order is based on a trailing change that is proportional to the actual decline in the stock’s price. Used to maximize earnings in the event that a stock’s price rises and minimize losses in the event that stock prices decrease.

4. Trailing Buy Stop Order:

Here, the stop parameter is determined by a trailing change in the stock’s real price increase. It helps maximize gains in the event of a stock’s price decline while avoiding losses in the event of a price increase.

5. Stop-Limit Order:

This type of order combines a limit order with a stop order. The stop-limit order tells the limit order to purchase or sell stocks at the specified price when the stop price is achieved.

How Does Stop-Loss Order work?

The stop-loss-order can be utilized in several ways. The most prevalent way is setting a price. Once the stock hits this price, an order to sell is immediately made. According to this order, the broker sells the shares at the current market price. In the case of short selling, the Stop Loss price initiates a purchase order. For example, if you anticipate that a stock valued at Rs. 100 would decline, you can set a Stop Loss at Rs80. Thus, you may still restrict your loss to Rs. 20 if the price decreases.

Setting the Stop Loss Price:

Stop-loss order cannot be set at a predetermined price. It varies between equities. This is mostly due to the fact that the degree of variation for each stock price will vary. Stock A’s price may grow or decrease by 10 percent during a month, but Stock B’s price tends to vary by no more than 5 percent. Thus, the Stop Loss may differ for each. When employing stop-loss order, it is essential to consider the investment term. As most short-term investors have a limited risk tolerance, their losses are often between 2 and 5 percent. Long-term investors typically employ a stop-loss order of 10 to 20 percent.

Trailing Stop Loss:

This Stop Loss variation protects gains. For example, you purchase a stock for Rs 100 and the price rises to Rs 120. The Trailing Stop Loss can then be set to a preset sum of Rs. 10 or 5 percent. The trailing stop loss order will be activated if the price of the stock falls below Rs. 120. If the price reaches Rs. 110 or falls by 5% to Rs. 114, the trailing stop loss will automatically issue a sell order to safeguard your winnings.

Bracket orders: You may also employ a mix of two stop loss orders with bracket orders to safeguard your earnings and minimize your losses. Suppose you purchase a stock for Rs. 100 and place a Stop Loss at Rs. 80 and a Trailing Stop Loss at Rs. You may also substitute another Limit Sell order for the Trailing Stop Loss. This order goes into effect if the stock price reaches a certain threshold, such as Rs. 120. Consequently, you may reduce the risk of your investing portfolio because your losses will be constrained.

Advantages Of Stop-Loss Order

Individual traders struggle to keep track of all the sectors, exchanges, and marketplaces. It is difficult for a single person to be current on all that exists. So that they might enjoy the Stop Loss benefits stated below.

  • This feature provides investors with protection against the risk of losing a substantial amount of capital.
  • Your trading account will be totally under your control, allowing for simple monitoring.
  • Multiple transactions are tough to track, but stop loss makes it easy.
  • The technology places the order automatically, relieving the trader of mundane tasks.
  • The order placement process is incredibly smooth.
  • The amount you are willing to gain or lose is totally your decision.

Disadvantages Of Stop-Loss Order

While a stop-loss order has a number of outlined benefits, it also has a sizeable number of disadvantages. These disadvantages are only understood by industry professionals who employ the tool appropriately.

Here are the ones you must be mindful of:

  • A minor decline or increase would certainly conclude a quite lucrative deal for investors. Under this procedure, a rapid order is issued in which stocks are purchased or sold promptly. Such a quick transaction diminishes the future earnings potential of stock ownership.
  • In addition, determining the rate for the transaction is the most difficult and complex aspect. There is no perfect rate or pricing, and there never can be.

Example Of Stop Loss Order

Providing a straightforward example for our readers, we’ve provided a Stop-Loss Order’s example in this post. This will clarify your notion in a practical manner. Suppose you own 20 shares of a corporation that you purchased for Rs. 510 each. The share’s current market value is Rs.570, and you anticipate more appreciation, therefore you intend to hold it. Now, you want to ensure that you do not lose all of the potential riches you have amassed thus far. Therefore, you may place a stop loss around Rs. 520. Therefore, your shares will be sold at this price if the price falls dramatically. You will not need to constantly check such a stock in order to maintain a price vigilance, taking into account your loss margin.

Conclusion: Stop-Loss Order

Price fluctuations are the fundamental characteristic of the stock market and the basis for the complete profit-and-loss structure. Stop-loss order is a terrific tool that provides you with quick and effective control over your transactions. The key characteristic of a stop loss order is the reduction of risk. Therefore, they may profit from such instruments, which are driven by trader interest and improvement. Take charge of your gains and losses the next time you engage in trading.

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Stop-Loss Order- FAQs

1.Ques: What is Stop Loss or Stop Loss Order?

Ans: A stop loss order is essentially an order filed with a stock broker to purchase or sell a certain stock at a predetermined price. It is intended to restrict the investor’s total loss on the securities holding.

2.Ques: How do you utilize Stop Loss?

Ans:  The first step is to access the order option, where you will discover the ‘add stop loss option. You must indicate the amount you can afford to lose on an investment, after which the order will be placed.

3.Ques: Is stop loss just beneficial for novices?

Ans:  Stop loss is a very useful precaution for newbies who are new to the market and are unaware of the losses that can occur as well as the profit trajectory of an investment. This eliminates the need for investors to constantly monitor the stock market in order to sell their shares at a price that would provide a profit.

4.Ques: What are the advantages of adopting Stop Loss?

Ans:  Constantly, investors worry losing a substantial amount of capital, but this function will alleviate their anguish. Your trading account will be totally under your control and simple to manage. Stop loss makes it simpler than ever to track several transactions. Orders are placed automatically by the system, relieving traders of their mundane duties.

5.Ques: Can it be used for intraday and F&O trading?

Ans:  It may be utilized for intraday and futures and options trading. By setting a stop-loss order, your losses will always be limited. It may be employed for both short-term and long-term investments, although day traders benefit the most.

6.Ques: Does every brokerage app provide a stop loss function?

Ans:  Virtually every brokerage app has this feature. By reducing the likelihood of losses, you encourage enormous returns on your investment, which are your long-term survival and vast profits throughout.

7.Ques: Question: Can I modify its intraday limit numerous times?

Ans:  It is possible to modify the stop-loss limit many times intraday. It is your protection against market volatility. Any trader who must endure volatility should utilize this service. It ensures that market weakness won’t put you in jeopardy under any circumstances.

8.Ques: Can I use stop-loss orders in Delivery Trading?

Ans:  A stop-loss by order under Zerodha, for instance, may be recorded as MIS or CNC. However, because delivery trades and CNC orders are intended for long-term investments, you must select the market order type rather than the SLM.

9.Ques: Do brokerage firms charge a fee for this feature?

Ans:  It is a rather potent instrument available to all traders and investors for limiting losses. The majority of brokers do not charge extra for this sort of order, making it more beneficial for traders.