A stop loss order is an order placed for an investor to buy or sell a stock. A stop loss order allows the investor to exit the market with a limited loss when the stock bought/sold by the investor starts making losses.
Stop loss means that whenever we enter into a trade, we decide how much we are willing to loss in that particular trade if trade went against us.
As you know market not always goes into our direction, sometimes our analysis go wrong and we start making losses. So, there should always be an exit plan to limit the losses.
If a trade goes against us then we cannot stay hopped that market will bounce back and our losing trade will start making profit for us; it is a newbie trader's thing. Professional traders always enter into trades with fixed stop loss strategies; therefore, in the long run they make money.
In stock market, it is often said that stop loss is our friend because it protects you from unlimited losses.
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What is stop loss order?
Stop loss order is a special type of order which only triggers after your decided price. In stop loss, you will be asked to enter two prices; Limit Price and Trigger Price.
Let us understand with an example suppose an investor has bought a share at the rate of ₹2000 and he is expecting that market will go bullish and stock will jump by ₹500 points and hit ₹2500 price tag. But at the same time, he knows that his analysis may be wrong and market instead can plunge by 500 points and stock could hit ₹1500 price. If the trade went against, he is not willing to loss ₹500 per share. So, he decides to exit from the trade if share price reaches to ₹1800.
In this case, investor is willing to loss ₹200 per share. So, he places a stop loss order of ₹1800. When he will be placing stop loss order, he will be asked to enter two prices; trigger price and limit price.
When stock price reaches to your entered trigger price, your stop loss order gets activated by the system and when it hits your limit price your stop order gets triggered and you exit from the market with limited loss.
Similarly, if investor does not trade with stop order then he incurs unlimited loss and that type of traders never make money in the stock market.
One rule you can must make right now is never ever dare to trade without a stop loss and your risk to reward ratio should always be more than one ratio one (which means for every ₹1 rupee risk, you reward should be more than that ideally ₹3 rupees).
For your information, trades who trade without stop loss never make money, blow up their accounts, exit from the market and never look back.
In fact, they are not called traders, they are gamblers who always hopes to win. Traders are not gamblers because they trade with knowledge and calculated risk.
What is trailing stop loss?
Trailing stop loss means you modify your stop loss in the direction of the market to book profit or at least close the trade at breakeven.
When market is going in your direction, you are making profit but sometimes all of sudden market turns against you and a big sharp move devours your profits and you start making loss.
How many times it happened to you?
I am sure you must have faced such a disappointing situation.
Solution for this is trailing stop loss.
Some traders also use stop loss order to lock their profits. When you would like to ride a trend then you can use stop loss order.
For example, let's say you have your trade is going in your redirection and you are not sure how long it will be in your favor but at the same time you are reluctant to exit from the trade because you want to ride the trend and book maximum profit.
As you know trend anytime can turn against you and your profit making trade can become loss making in a blink of eye. So in this type of scenario what you can do is you can start trailing your stop loss. And you can keep doing so until it gets triggered.
Let's understand it to with the help of an example. Suppose you have bought a share for₹1000 and your target price is ₹1500. Now it is clear that the market will not go straight up, it will move in zigzag pattern. And it is also possible that the stock price starts falling from right form ₹1000. So to exit from the trade with fixed loss we have to place a stop loss order, in this example I am taking ₹900 as stop loss. Which means if the stock price goes below ₹900, we will sell all our shares and will close our trade with a loss of ₹100 per share.
Now let's say market is rallying towards our target and now stock is trading at ₹1100. Now we will trail our stop loss from ₹900 to ₹1000. For that purpose, we will modify our stop order and new stop price will be ₹1000.
Did you notice? That now we are at breakeven point. Here if our stop order gets triggered then we are not going to loss anything.
Again, suppose, after an exhaustion period, stock surged and now trading at ₹1200.
What should we do now?
I am sure you got it. Now we will again trail stop loss from ₹1000 to ₹1100.
Now we are in a profitable trade. If our trailing stop loss gets triggered then we will get a profit of ₹100 per share.
This way you can keep moving your trailing stop loss order in the market direction and ride the trend until it is over.
Ideally you should place your trailing stop loss order below or above recent swing high or low (according to your trade if your position is long then you will place order below the swing high or vice versa) or some traders also prefer to trail stop loss in percentage for example if market goes up by 1 percent then they trail stop loss by 1 percent.
This way you can take advantage of trailing stop loss.
Advantages of stop loss order
- Trader does not have to pay any additional charges for placing stop loss order.
- Once the stop loss order is executed, brokerage will be charged as per the brokerage plan (usually ₹20 excluding taxes).
- When you know you are going to loss fixed amount of money then it becomes much more easy to handle your emotions when trade is not going in your direction.
- Most of the newbie traders do not place stop loss order and when they start making loss, they just hope that market will come back and their will start making profit or at least their loss will be covered. It seldomly happens and such traders exit from the market after losing their hard earned money. Stop loss orders allow you to exit the market at a limited loss.
- If you have placed stop order then you don't need to watch the market for all the time. After executing and placing stop loss order, you can go out or can do your routine work.
Disadvantages of stop loss order
- Sometimes fake breakouts can trigger stop loss order. Solution for the is place your stop order at ideal place (not so far, not so close).
- There are no strict rules for the level at which the stop should be placed and it completely depends on the investment style of the investor.
- If you trade in delivery then you have to place your stop loss order every day because the stop loss order gets canceled automatically when the market is closed.
Perfect place to add stop loss order
First of all, let me clear that no matter where you place your stop order, it will be triggered many a times. And stop loss order entirely depends upon your trading style, risk appetite and the like.
But there are some perfect places where smart traders place their stop loss orders. One of them I strongly suggest you use is find recent major support or resistance (depending upon your position: short or long) and add average true range in it.
Such a stop loss order may be consider ideal, in my opinion, because if it gets triggered then there will be no mistake of you. You placed your stop order at ideal place. For your information, such orders seldomly hit.
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