One of the services available while placing orders to buy or sell shares is ‘Stop Loss’. This, though, is not well understood.
Here are five things to know about Stop Loss orders.
When you buy a stock, you expect it to rise to a certain level. However, the market fluctuates in the short term because of various factors. A Stop Loss protects you from drastic fluctuations. Through the Stop Loss, you are giving an instruction to your broker to sell the stock at a certain price automatically. This price is usually lower than the price at which you bought those stocks. This way, you don’t have to monitor the stock directly to cut your losses. Such orders are called ‘Cover Orders’.
The option can be used in different ways. The most method is to set a price. Once the stock touches this price, an order is placed automatically to sell the stock. The broker then sells the stock at the prevailing market price. It can also be used while short-selling. In this case, the Stop Loss price point will trigger a buy order. For example, suppose you expect a stock worth Rs. 100 to fall by Rs. 10; you can set a Stop Loss at Rs. 102. This way, in case the price rises, you can limit your loss.
There is no set rule for the price at which you should set a Stop Loss. It differs from stock to stock. This is because the degree of fluctuation for each stock is different. For example, Stock A has a tendency to fall or rise by 10% in a month while Stock B fluctuates only by 5%. In this case, the Stop Loss may vary. This is why analysts consider the stock’s volatility as well as its ‘Support’ and ‘Resistance’ levels. Also, keep in mind the duration of your investment. Short-term traders usually have a low threshold. Their Stop Losses often are 2-5%. Long-term investors can afford to set a greater Stop Loss of 10-20%.
This is a variant of the Stop Loss feature. The difference is that this helps you protect your profits. Suppose you buy a stock at Rs 100 and it increases to Rs 120. You can set a Trailing Stop Loss. This can be a fixed amount of Rs 10 or a percentage, say 5%. The Trailing Stop Loss is triggered once the stock falls from Rs 120. The moment it touches Rs 110 or falls by 5% to Rs 114, the Trailing Stop Loss places a sell order for the stock. This way, your profits are protected.
You can use two Stop Losses as a combination. This helps you protect your profits as well as reduce your losses. It works in a simple way: Suppose you buy a stock at Rs 100, set a Stop Loss at Rs 80 and a Trailing Stop Loss at Rs 10 just like the previous example. Alternatively, you can replace the Trailing Stop Loss with another Limit Sell order. This order kicks in once the stock price touches a certain high price of say Rs 120. This way, you limit the risk in your portfolio because your losses are limited.
You can use ETFs for a Stop-Loss strategy too. Here’s how. Read more
How to set a stop loss for your trades. Read more
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