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The "STOP-LOSS" Order: Not Just for Preventing Losses

Posted on 28 November, 2015 at 8:55

 

 

Hi Friends,

I know its been a long time that  we have posted anything on our website, but believe me we were really busy with our clients and making strategy to earn money for them.  In this past one month have seen many ups and downs for specific stocks and market as whole was in downtrend. We have seen upside in Tata Motors, Motherson sumi, Cupid, Aviation Stocks etc.. and downtrend in Dr. Reddy, Sun Pharma, Tree House etc..which were star performers for many of the fund house in the recent past.

Also I am sure what we have learnt in this was that retail investor have once again burn their fingers and lose their hard earned money at the same time. This was just because they were emotionally attached to these stocks and were wrongly advised by TV anchors and advisors to buy and short these scripts at high or low point.

Investor have not burn their finger because of their advise but because they failed to apply stop loss advised by them in some or the many cases. Financial adviser used this tool so called STOP- LOSS very smartly for their clients they track and monitor but for retail investor they have to control and apply it by their own. And Most of the time they failed to do the same.

So as HamaraProfit mission says that "we want to educate our clients and customers who visit us with good faith", We really want to teach them about " Stop- Loss" order and if you like the same then please share, like and give your valuable comments.

 

What Is a Stop-loss Order?

It is an order placed with a broker to buy or sell once the stock reaches a certain price. A stop-loss is designed to limit an investor's loss on a security position. Setting a stop-loss order for 10% below the price at which you bought the stock will limit your loss to 10%. For example, let's say you just purchased Tata Motors at 300 Rs. per share. Right after buying the stock you enter a stop-loss order for 270 Rs. This means that if the stock falls below 270 Rs, your shares will then be sold at the prevailing market price.

 

Positives and Negatives

The advantage of a stop order is you don't have to monitor on a daily basis how a stock is performing. This is especially handy when you are on vacation or in a situation that prevents you from watching your stocks for an extended period of time.

 

The disadvantage is that the stop price could be activated by a short-term fluctuation in a stock's price. The key is picking a stop-loss percentage that allows a stock to fluctuate day to day while preventing as much downside risk as possible. Setting a 5% stop loss on a stock that has a history of fluctuating 10% or more in a week is not the best strategy. You'll most likely just lose money on the commissions generated from the execution of your stop-loss orders.

 

 

Another thing to keep in mind is that once your stop price is reached, your stop order becomes a market order and the price at which you sell may be much different from the stop price. This is especially true in a fast-moving market where stock prices can change rapidly.

 

 

Not Just for Preventing Losses

Stop-loss orders are traditionally thought of as a way to prevent losses thus it's namesake. Another use of this tool, though, is to lock in profits, in which case it is sometimes referred to as a "trailing stop". Here, the stop-loss order is set at a percentage level below, not the price at which you bought it, but the current market price. The price of the stop loss adjusts as the stock price fluctuates.

 

Continuing with our Tata Motor example from above, say you set a trailing stop order for 10% below the current price, and the stock skyrockets to Rs. 400 within a month. Your trailing-stop order would then lock in at Rs. 360 per share (400 - (10% x 400) = 360). This is the worst price you would receive, so even if the stock takes an unexpected dip, you won't be in the red. Of course, keep in mind the stop-loss order is still a market order - it's simply stays dormant and is activated only when the trigger price is reached -- so the price your sale actually trades at may be slightly different than the specified trigger price.

 

Advantages of the Stop-Loss Order

  1. First of all, the beauty of the stop-loss order is that it costs nothing to implement. Your regular commission is charged only once the stop-loss price has been reached and the stock must be sold. You can think of it as a free insurance policy.
  2. Most importantly, a stop loss allows decision making to be free from any emotional influences. People tend to fall in love with stocks, believing that if they give a stock another chance, it will come around. This causes you to give the stock yet another chance to move as what you want . In the meantime, the losses mount....
  3. No matter what type of investor you are, you should know why you own a stock. This also means that if you are a hardcore buy-and-hold investor, your stop-loss orders are next to useless.
  4. The point here is to be confident in your strategy and carry through with your plan. Stop-loss orders can help you stay on track without clouding your judgment with emotion.
  5. Finally, it's important to realize that stop-loss orders do not guarantee you'll make money in the stock market; you still have to make intelligent investment decisions. If you don't, you'll lose just as much money as you would without a stop loss, only at a much slower rate.

Conclusion

A stop-loss order is a simple tool, yet so many investors fail to use it. Whether to prevent excessive losses or to lock in profits, nearly all investing styles can benefit from this trade. Think of a stop loss as an insurance policy: you hope you never have to use it, but it's good to know you have the protection should you need it.


Regards

HamaraProfit

 

 

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1 Comment

Reply Ravi Verma
11:08 on 8 January, 2016 
Nice post,,, thank you for sharing the same. But is it necessary for every trade or just a good practice.