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Highlights
Stop-loss plays an important role in the stock market.
It helps to cut a portfolio’s risk exposure significantly.
But it needs proper understanding to successfully place a stop-loss order.
Stop-loss plays an important role in the stock market. It is a kind of order which is used to limit losses or lock in a profit when the security reaches a certain price. In short, a portfolio’s risk exposure can be cut down by placing a stop-loss order.
To understand it better, let’s suppose a trader buys a stock at a price of AU$10 and places a stop-loss order at AU$9.50. In this case, the stop-loss order would be executed when the stock price hits AU$9.50, protecting the trader against a further loss if the share price begins to slip.
However, it needs a proper understanding of the concept to successfully place a stop-loss order. Investors or traders can book losses if a stop-loss order is placed too far when the market is making opposite moves. On the other hand, setting up a stop-loss order too close can force one to lose the market position too quickly.
Placing a stop-loss order
As already explained, a stop-loss order should be set up in such a way that it restricts financial losses. According to the percentage method, losses can be limited by 20% for a stop-loss order placed at AU$24 in the stock bought at AU$30.
However, there is no single strategy which may help you restrict losses while placing a stop-loss order. There are several theories based on universal placement, implying executing 6% trailing stops on all securities.
Traders can also employ the support method. The method is about placing hard stop losss at fixed prices. But one needs to conduct proper research before executing it since finding out a stock’s most recent support levels holds the key. A stop-loss order can be set up just below the level once a support level is found out.
Traders can also apply the moving average method which involves placing a stop-loss just below the longer-term moving average price.
One should also consider stock market volatility while using stop-losses. Volatility can be measured to gauge typical price movements on a particular day to place a stop-loss outside normal fluctuations.
Four things to keep in mind
- Stop-loss orders do not play a role in active trading.
- Such orders have no role in case of the large block of shares.
- Brokerage fees should always be kept in mind since brokers charge different amount for different orders.
- Investors should never assume that a stop-loss order has been executed. They should always wait for the confirmation of the order.