Importance of Setting Stop Losses
When it comes to trading
and investing in stock market, one of the most important things is risk
management. No matter how much you analyse the market trends, there is always a risk that
the market will show high volatility. In such situations, using a stop loss can
help you sail through. With stop loss, you can control the amount of money you
lose on a stock. Stop loss helps to protect your assets.
What Is Stop Loss?
Stop loss is an
order placed with the stockbroker to buy
or sell a stock once it reaches a certain price. It is designed to limit a
trader’s loss if the price shifts
opposite to his expectations. In simple words, the purpose of stop loss is to
get you out of the stock position before the price falls further. It indicates
maximum loss that a trader is willing to absorb.
It is not wrong to
say that, setting stop loss prevents trades from becoming investments and in
turn saves investments from becoming headaches.
How does Stop Loss Work?
You can set the stop loss order at a certain
amount yourself if you use an online trading platform. If you trade
through a broker, you can ask your broker to set the stop loss order. There is
no thumb rule which signifies the level at which you can place a stop loss. It
completely depends on your trading
strategy. If you are an active trader, you might place a stop loss at 5% below the current market price
or the price at which you bought the shares. Similarly, if you are a long-term investor, you might place the stop
loss at 15% or more. Now when the stock hits your set price, your shares will
automatically be sold at the prevailing market price.
Example of Stop Loss
Let us say, you have
bought 100 shares of L&T at Rs. 1700 per share. You expect a target price of Rs. 2040 per
share so as to earn a profit margin of 20%. Right after buying the shares, you
also entered a stop loss at 10% below the
buying price, which is at Rs. 1530 per share. Now if the market crashes and
L&T moves down, you are still saved
from incurring heavy losses. As the price will hit Rs. 1530, your shares will
be immediately sold at the prevailing market price and you will incur a minimum loss which you had assumed. Stop loss
puts a limitation on your downside.
Why is Stop Loss
The general tendency
of any trader is to book the profit quickly. At the same time, traders hold on
to the loss making stocks in the hope
that they will bounce back in future.
The fear of loss compels them to hold the stocks even if the prices go
down. During adverse market conditions, this behaviour
can lead to huge losses as there is no cap on the amount you could lose. So it
is strongly advisable to have a stop loss which will restrict your losses or limit
One of the best advantages of placing a stop
loss is that you don’t have to
monitor the performance of your stocks throughout the day. So next time when
you are on a vacation, this can be a smart way to protect your investments.
Protecting your investments is a smart way to invest in stock
market. If you are not willing to hold your investments for long, then
it is a good idea to set stop loss. Stop loss is a great tool if used properly,
yet many investors fail to use it. You should think of stop loss like an
insurance policy; it costs you nothing but in situations when your call on the
market goes wrong, it can protect you and save a fortune.
At Indira Securities,
we conduct training
programs for novice traders and investors. Our experts teach you proven and profitable trading strategies
which can help you make better trading and investing decisions. We offer regular courses as
well as provide on demand courses. You
can also open a Demat account with us and
enjoy our low brokerage cost along with quality services.