Stop loss orders, if used properly, can come as a very handy tool for small investors in many market situations. They can be deployed into any strategy and help in automating the selling process.
Stop loss orders: A stop order work acts as a buffer in that if a trade does not develop as expected, an investor can have his position automatically sold for a loss. For instance, if he is holding 100 shares of a company at Rs200 per share and he can afford to lose only up to 10% of his investment, a stop loss order will sell his holding automatically if the company’s stock drops below Rs180.
Types of Stop Orders: There are two types: stop market orders and stop limit orders. The former automatically sells the shares allotted upon the order’s activation. If the pre-set stop price is Rs100 a share, a market order will be immediately placed to sell the stock as soon as it touches this price. Meanwhile, stop limit orders automatically places a limit order once trigger price is touched. When placing such an order, the investor must also decide on the limit order he wants.
Why use stop orders
Insurance against losses: This is the main reason why retail investors opt for stop loss orders because they get insured against possible greater losses.
Automation of trading: Investors need not be physically present to activate a stop loss order.
Drives disciplined investing: Investors can hold on to an overall strategy which makes them more consistent and successful over time. They can also learn to minimize possible losses every time they trade.
Simpler: Due to its automated nature, stop loss orders keep the selling aspect of trading very simple.
Keeps market emotions at bay: Investing is business and no business can be successful if emotions are allowed to hold sway over reason. Stop loss orders help significantly in alleviating emotions and perhaps, greed.
Flexibility: Stop loss orders provides flexibility of position management as they can be used to manage losses in certain percentages such as 2%, 5% or 10%. For more experienced traders, using stop limit orders provide them with even more options for how to play a position once the stop loss is activated.