When weighing the positives and negatives of buying stocks, it's easy to overlook several essential factors that should be taken into account. There is a chance that stop-loss orders had a part in this.

What Exactly Is a Stop-Loss Order?

An order to purchase or sell a particular stock when it reaches a specific price is known as a stop-loss order. Using a stop-loss order, an investor's exposure to a security's loss can be limited. An example is using a stop-loss order to restrict your loss, say, 10% of the price at which you purchased the stock.

Assume you've just acquired a $20 share of Microsoft (MSFT). You immediately place a stop-loss order of $18 after buying the stock. Your stock will be sold at the current market price if it goes below $18.

A Guide to the Use of a Stop-Loss Order

For most traders, the stop-loss order is moved to safeguard some of the trader's earnings after the transaction displays a reasonable profit margin. Following the previous example, assume that the price of EUR/USD rises to 1.1600 after the trader buys it for 1.1500.

The trader may then adjust their stop-loss order up to 1.1540, safeguarding half of their current profit if the market declines. When the market price rises, traders may employ a "trailing stops" strategy to raise their stop-loss order automatically. On most trading systems, trailing stops may be readily implemented.

Advantages of the Stop-Loss Order

A stop-loss order has the significant advantage of being completely free to use. Once the stop-loss price is reached and the stock must be sold, you will be charged your usual fee. 3 A stop-loss order can be compared to a free insurance policy.

In addition, stop-loss orders don't necessitate a daily review of a stock's performance. When you're on vacation or otherwise unable to keep an eye on your investments, this feature is useful.

Stop-loss orders also protect your trading decisions from the effects of your emotions. Regarding stocks, people tend to "fall in love." For example, people may believe that if they give a store a second opportunity, it will turn around and return to profitability.

Stop-Loss Orders Are Another Way to Preserve Profits

These directives have long been considered a strategy to avoid losses. However, this method may also ensure that gains are not lost in the future. Stop-loss orders are sometimes referred to as "trailing stops" in this context.

The cost of the stop-loss might change depending on how the stock price moves. If a stock rises in value, you will have an unrealized gain; you will not get the money until you sell the asset. While letting your increases run, you have the assurance of at least some realized capital gain thanks to the use of a trailing stop.

Using the Microsoft example from earlier, let's say you put a trailing stop order at 10% below the current price, and the stock soars to $30 within a month.

Stop-Loss Orders Have Drawbacks

If a stock's price fluctuates for a brief period, the stop price will be activated, which is the primary drawback. Stocks that have historically fluctuated by 10% or more each week may not be the most outstanding candidates for placing 5 percent stop-loss orders. If your stop-loss order is executed, you will most likely lose money on the commission.

The level at which stops should be set does not have any hard-and-fast rules; it is entirely dependent on the investment style of the person. There are two types of investors: those who are active traders and those who are long-term investors.

Short selling Stop-Loss Order Location

A stop-loss order on a short sale should not be placed at a random level as when you're buying a stock. Allowing the market some wiggle space while yet protecting yourself from loss is what you're aiming for.

A typical stop-loss order for short selling falls just above a "swing high," as opposed to purchasing. Swing high finds opposition at its highest point, just like swing lows find support at their lowest point. It's a common occurrence when the price goes up and then down. If you're going to trade, you want to go with the flow. The swing highs should be going downward.

Summary

The implementation of a change order is an essential strategy that has the potential to result in significant advancements. This tool might be helpful whether your goal is to minimize losses as much as possible or to maximize potential profits. Stop-loss orders are comparable to a form of insurance in the following ways: Being prepared may be a source of solace in trying times, even if the preparations themselves aren't put to use.