What is a Stop Loss Order?

What are Stop Loss Orders?

A stop-loss order is an order made to purchase or sell a certain stock when it reaches a predetermined price. The order type instructs a broker to purchase or sell a certain stock whenever it hits a given price. Its goal is to limit an investor's losses on a security holding. For example, placing a stop-loss order 10% below the price at which you purchased the stock will restrict your loss to 10%. This strategy is commonly used in web trading to minimize risks.

How Does a Stop Loss Order Work?

Stop loss order automatically affects the sale of a particular share once the price touches a certain level. This point is known as the stop price. When an investor or trader decides to place a stop loss order, they choose a certain price (stop price) at which the order would be initiated.

Now, if the stock’s price approaches the stop price, the stop loss order frequently turns into a market order. This consequently implies that the share will be offered at the best price possible, which may not be the same price as the selected stop price in the order.

The mechanics of this tool basically revolves around the inability of the investors to incur huge losses in case there is a negative trend in the value of a specific stock.

Types of Stop-Loss Orders

Here is a brief overview of the many stop-loss order types and their brief descriptions:

1. Fixed Stop Loss

The fixed stop is a stop-loss order that activates automatically when a particular predetermined price is hit. Fixed stops can also be timed-based and are most commonly used as soon as the trade is placed.

Time based fixed stops are relatively appropriate for the investors who wish to give the position a certain time to make profits before it is switched to another trade.

2. Trailing Stop Loss

A trailing stop-loss order is a type of stop-loss order that allows investors to define a specific stop-loss level that moves as the price of the stock changes. Simply put, there is a specified percentage that lets you track the growth of your position and alter your stop loss accordingly.

It is set as a percentage of the overall asset price, and the order to sell is activated if market prices fall below the specified level. However, if prices rise, the trailing order automatically adjusts to reflect the general increase in market worth. In a downward market, this order serves to limit possible losses while holding in profits.

Stop-Loss Order Vs Market Order

The main difference between a stop-loss order and a market order is that a stop-loss order instructs your broker to purchase or sell a stock once it hits a specific price, whereas a market order executes immediately at the current market price.

A stop-loss order is used to sell the underlying securities on the basis of a certain price level, which is fixed below that level. At the same time, a market order is an order given to the broker for the purchase or sale of securities at the market price.

Stop loss orders are used to support the risk factor while market orders seek to improve the liquidity level in the stock market, eliminating the bid-ask spread differences. A market order is, as we have noted, the simplest type of trade order introduced in a stock market.

Stop-Loss Order and Limit Order

Limit orders execute a trade of specific securities at a given price once that price is attained at a predetermined value. A buy limit order helps make the purchase of any stocks while the price falls below a specific limit, whereas a sell limit order is one that occurs when the price surges to the said value.

A limit order aims to let investors execute trade better by achieving the maximum bid-ask spread percentage. It is in contrast to a stop loss order, which is executed only if the price is equal to the limit set by the investors. It is a technique of risk minimization in a bear market.

Advantages and Disadvantages of Stop-loss Order

Here are the advantages and disadvantages of stop-loss orders:

Advantages of Stop-loss Order

• Risk Control: Stop-loss orders can allow investors to manage risk by protecting capital and limiting their losses.
• Loss Minimization: By using a stop-loss order, traders can protect their trading capital from suffering significant losses.
• Discipline: Stop-loss orders enforce disciplined trading as it has predefined exit points, and traders cannot be driven by emotional decision-making.

Disadvantages of Stop-loss Order

• Short-term Fluctuations: It can sometimes be triggered by short-term swings in stock prices.
• Selling Stocks Too Soon: Stop-loss orders have the possibility of being stopped out of a successful deal.
• Costly: Your stock broker may charge you for using a stop-loss order, which will be added to the brokerage fees.

Conclusion

Stop-loss is an important tool for every investor and trader to reduce loss and lock in profit. It helps mitigate the risk of investors by reducing potential losses and shielding their investment from market volatility. For a comprehensive understanding of online trading, check out our guide.

Open a free Demat account with Almondz Trade today to use the stop-loss orders for locking in profits. You can also empower yourself to strike a balance between profit potential and safeguarding capital.