What is Stop Loss?
A stop loss is an order to buy (or sell) a security
once the price of the security climbed above (or dropped
below) a specified stop price. When the specified stop
price is reached, the stop order is entered as a market
order (no limit) or a limit order (fixed or
pre-determined price). With a stop order, the trader
does not have to actively monitor how a stock is
performing. However because the order is triggered
automatically when the stop price is reached, the stop
price could be activated by a short-term fluctuation in
a security's price. Once the stop price is reached, the
stop order becomes a market order or a limit order.
In a fast-moving volatile market, the price at which
the trade is executed may be much different from the
stop price in the case of a market order. Alternatively
in the case of a limit order the trade may or may not
get executed at all. This happens when there are no
buyers or sellers available at the limit price.
Types of Stop Loss order
1) Stop Loss Limit Order
A stop loss limit order is an order to buy a security at
no more (or sell at no less) than a specified limit
price. This gives the trader some control over the price
at which the trade is executed, but may prevent the
order from being executed.
A stop loss buy limit order can only be
executed by the exchange at the limit price or lower.
For example, if an trader is short and wants to protect
his short position but doesn't want to pay more than
Rs.100 for the stock, the investor can place a stop loss
buy limit order to buy the stock at any price up to
Rs.100. By entering a limit order rather than a market
order, the investor will not be caught buying the stock
at Rs.110 if the price rises sharply.
Alternatively a stop loss sell limit order
can only be executed at the limit price or higher.
Advantages and disadvantages of the stop loss limit
order
The main advantage of a stop loss limit order is that
the trader has total control over the price at which the
order is executed. The main disadvantage of the stop
loss limit order is that in a fast moving volatile
market your stop loss order may not get executed if
there are no buyers/sellers at the limit price. 2)
Stop Loss Market Order
A stop loss market order is an order to buy (or
sell) a security once the price of the security climbed
above (or dropped below) a specified stop price. When
the specified stop price is reached, the stop order is
entered as a market order (no limit). In other words a
stop loss market order is a order to buy or sell a
security at the current market price prevailing at the
time the stop order is triggered. This type of stop loss
order gives the trader no control over the price at
which the trade will be executed.
A sell stop market order is a order to
sell at the best available price after the price goes
below the stop price. A sell stop price is always below
the current market price. For example, if an trader
holds a stock currently valued at Rs.100 and is worried
that the value may drop, he/she can place a sell stop
order at Rs.90. If the share price drops to Rs.90, the
exchange will sell the order at the next available
price. This can limit the traders losses (if the stop
price is at or below the purchase price) or lock in some
of the profits.
A buy stop market order is typically used
to limit a loss (or to protect an existing profit) on a
short sale. A buy stop price is always above the current
market price. For example, if an trader sells a stock
short hoping the stock price goes down in order to book
profits at a lower price, the trader may use a buy stop
order to protect himself against losses if the price
goes too high.
Advantages and disadvantages of the stop loss market
order
The main advantage of a stop loss market order is that
the stop loss order will always get executed. The main
disadvantage of the stop loss market is that the trader
has no control over the price at which the transaction
is executed. Conclusion
Stop loss orders are great insurance policies that cost
you nothing and can save you a fortune. Unless you plan
to hold a stock forever, you should consider using them
to protect yourself.
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