What is Stop Loss? Stop-loss order explained.

What is Stop loss?

Stop Loss or Stop Loss order is an advance order placed with the broker. To buy or sell an asset at a certain price. Stop Loss orders are designed to help a trader limit his or her losses while trading an asset. This is an automatic order that an investor places with the broker by paying a certain amount of brokerage. By placing a stop-loss order, the investor instructs the broker/agent to sell a security when it reaches a predetermined price limit.

Most investors believe that a Stop Loss order only protects a long position. However, it is not the case, It can also protect a short position by buying back the asset at the predetermined price. A Stop Loss, If used wisely can produce numerous benefits for a trader.

Example of a Stop Loss

Suppose you bought 500 shares of “Reliance Industries Ltd” at the price of ₹ 2000 each. And set up a Stop Loss order at ₹ 1800. Now in case if the prices of “Reliance Industries Ltd” plunge below your Stop loss For example at ₹ 1700 or even ₹ 1799. Your Stop loss order will get triggered, and The trade will be executed at the prevailing market price.

Benefits of Stop Loss order

The most amazing benefit of a Stop Loss order is that Doesn’t Cost anything. Most brokers today Charge regular commissions. Even after your Stop Loss order gets triggered. Another way of looking at the stop loss is as of a free insurance policy. In addition Stop Loss order Facilitates emotion-free decision making. It is in the Nature of traders to Acquire false senses of belief over Stocks. And try to trade with them repeatedly even after facing heavy losses. This may lead a trader to doubt his or her trading strategy.

At the end of the day, A trader has to believe in the strategies and plans. Most importantly a Successful trader Should always be confident about the plan. Stop Loss order helps a trader to Continue on the right path. In conclusion, The advantage of the Stop Loss order is that It can help you stay on track and prevent your judgment from getting clouded with emotion.

Disadvantages of Stop Loss order

The Main Disadvantage of a Stop loss order is that sometimes insignificant price movements can trigger it. In other words, Sometimes a trade may not be able to execute a profitable trade just because of one quick move of price in the opposite direction. The key is to pick a Stop Loss point that allows the price to fluctuate while preventing as much risk as possible.

Trailing Stop Loss

Traditionally Stop Loss orders have been used to prevent losses. However, Another way of using Stop Loss orders is to Book profits. In this case, a Stop loss order is referred to as “Trailing Stop Loss”. Here, a Trader Puts a Stop Loss order below the current market price rather than below the entry price. The main Objective of Trailing a Stop loss is to protect the profits.
Example of a Trailing Stop loss :

Suppose you bought 100 shares of “Adani Power Ltd” at ₹ 1000 each, And The price of the shares moves up to 1200. A trader will Trail his Stop Loss around 1150, in order to protect the profits as well as aim for the price to move further up. The Trailing stop loss will ensure that if the price moves downwards, The trader will be able to save the profits earned Through the previous price move.

Summary

Stop Loss is a useful and effective tool, But most Traders fail to use them to their benefit. However, to effectively use a Stop Loss, A trader should have a proper trading strategy. All types of traders and investors can benefit from Stop Loss orders, whether to Prevent losses or to book profits.

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