A stop-loss order is designed to limit an investor’s loss on a position in security. It is the maximum loss that the investor wishes to take while in a stock market position.It is an automatic trading order which is being used by the traders to cut their losses. The law is executed automatically, which saves you having to monitor your deals continually. It also serves as protection from excessive losses.
Stop loss are an extremely beneficial and essential tool when it comes to trading. There is much volatility in the market. Many instruments change their prices every hour even minutes. Global markets operate day and night, making it virtually impossible for a single trader to follow multiple deals on a variety of shares, commodities, currencies, and indices. Stop loss orders help the traders to monitor the changes occurring in the market carefully and will help them protect a trader’s balance.
Effect of Stop loss on trading
Just like every coin has two sides, stop loss trading has its own sets of advantages and disadvantages too. Taking about pros first, below are some of the benefits of stop-loss trading.
- It helps you monitor multiple deals at one point in time.
- It enables better control over your account.
- Stop loss orders helps you to decide what amount you are willing to risk while trading.
- It’s one of the most significant advantages is that it offers you protection from excessive losses.
- This technique is easy to implement which helps you to control your losses.
- You don’t need to pay much attention to it as it is executed automatically, at any time.
When we talk about the disadvantages, the main problem we face here is that sometimes it limits the profit potential as well. It may result in closing the deals too soon. Not only this, but the traders must also decide the rate which they want to set. It is a tricky task to do.
Stop loss order is classified into various categories depending on different parameters. Based on the execution mode, a stop-loss order can be classified as healthy stop loss or stop loss follower. If the broker guarantees the stop loss, we have secured stop loss order or unsecured stop loss order. It can be classified as paid stop loss or free stop-loss if the broker charges us the execution of the stop-loss order and if the broker imposes the minimum distance between stop loss level and stock price, then it can be categorized as stop-loss with minimal distance or stop loss without minimum distance.
Most investors associate a stop-loss order only with an extended position; it can also be used for a short job, in which case the security would be bought if it trades above a defined price.
Experienced traders understand that Stop Loss orders are not a perfect solution however you should use them carefully as they should be used because they can also limit potential profits by efficiently closing a deal too soon. Hence one must use stop-loss trading very sensibly and thoughtfully.