Stop loss orders –A way to protect your capital

It is an order placed with a broker to buy or sell once the stock reaches a certain price. A stop loss order works like this: You tell your broker you want a stop loss order at a certain price on the stock. When, and if, the stock hits that price, your stop loss order becomes a market order, which means your broker sells the stock at the best market price available immediately.

The main advantage of a stop loss market order is that it costs nothing to implement. Your regular commission is charged only once the stop-loss price has been reached and the stock must be sold. You can think of it as a free insurance policy. Most importantly, a stop loss allows decision making to be free from any emotional influences. People tend to fall in love with stocks, believing that if they give a stock another chance, it will come around. This causes procrastination and delay, giving the stock yet another chance. In the meantime, the losses may mount wiping out a substantial figure.

Here is an important point to remember:

Be careful where you set your stop loss . If a stock normally fluctuates Rs 10-15, you should’nt set your stop loss too close to that range or it will sell the stock on a normal downswing.

TRAILING STOPS

Another use of this tool is to lock in profits, in which case it is sometimes referred to as a “trailing stop”. A trailing stop loss is fixed at a certain percentage below the current market price of the stock you own. The trailing stop loss percentage depends on how volatile the stock is. If the stock begins to go down and the trailing stop loss gets triggered, you would be able to book your profits in the deal. However, if the stock goes up, you will be bringing the trailing stop loss up to maximize your profits.

For example – you bought shares in , say , Reliance for Rs 1000. The Current market price of the share is Rs 1100 .So you set the trailing stop at, say Rs 1070 so that in the event of stock price crash, your sell is at Rs 1070 booking a profit of Rs 70 per share . Now instead of stock prices coming down, suppose it went up to Rs 1200 .now, you may want to fix the trailing stop at 1160, locking a profit of Rs 160 per share.

VERY USEFUL FOR DERIVATIVE TRADERS

Big bucks are at stake when you enter futures and options. Stop loss orders are particularly useful for traders of derivatives.

MARKET ORDERS AND LIMIT ORDERS

The stop loss order can be stop loss market orders or stop loss limit orders. The difference is that A stop loss limit order is an order to buy a security at no more (or sell at no less) than a specified limit price. This gives the trader some control over the price at which the trade is executed. In a stop loss market order, the trader has no control over the price at which the transaction is executed.

PROS AND CONS

The other positive factor of stop loss orders is that you don’t have to monitor on a daily basis how a stock is performing. This is especially in a situation that prevents you from watching your stocks for an extended period of time.

The disadvantage is that the stop price could be activated by a short-term fluctuation in a stock’s price. The key is picking a stop-loss percentage that allows a stock to fluctuate day to day while preventing as much downside risk as possible.

You may like these posts:

  1. Buying & Selling shares
  2. Online vs. Offline
  3. The Broker’s role in investing.

1 Response to “Stop loss orders –A way to protect your capital”

anil

July 29, 2013 at 6:44 am

hi sir,

very informative thanks. i would like to know how would stop loss works for long time investment do i have to change the stop loss daily or is it ok if i just keep changing when
the price goes up
with regards
anil

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