What is Stop Loss?

One of the basic mantras to be successful in trading is to keep your losses under control. The risk involved in each of your trades is directly related to the loss you incur. The bigger the risk you take, the higher your profit target will be, but the possibility of loss also increases. Therefore, before entering into any trade, it is very important to calculate the possible loss and there is a way to control this loss which is called stop loss. If you are active in trading or are thinking of doing it, then it is very important for you to know about stop loss. Through today’s article, we will try to give you information about stop loss and its importance.

What is Stop Loss?

Stop loss is a buy or sell order that protects the trader from losing more than a limit on the trade taken. This order helps the trader in reducing the losses due to market volatility by keeping his losses within the limit.

The stop loss order can be set by the trader as per the risk taken in his trade. For example, a trader has bought some stocks for Rs 100 on intraday basis and his target price is Rs 106. The trader does not want to take more than 3% risk on this trade so he can set a stop loss order at Rs 97. This is an advance order that you can place at the time of taking the trade or after taking it. If the trade goes in your favor then you can book profit, but when the trade goes in the opposite direction, your shares will be sold automatically due to the stop loss order as soon as the price reaches 97. In this way the possibility of loss in the trade will be limited to just 3%.

Why is stop loss necessary?

The stock market is full of uncertainty and only those who protect their capital from loss can stay here for a long time. To control losses, it is very important to keep your risk strategy in mind. When you have clarity about the maximum loss you can take in a trade and at what price you have to close the trade, only then you will be able to become a good trader.

Here your question may be that as an active trader, we can keep an eye on the trade as long as we are in it and as soon as the price comes within our loss range, we can sell it, then what is the need of stop loss in such a situation? ? In such a situation, it is important for us to know that the price of the stock changes every second in the stock exchange and sometimes it changes rapidly and crosses your set price in the blink of an eye and you do not get a chance to place the order. Finds. Even if you place an order, it cannot be executed. In such a situation, the stop loss ensures that the order is executed only at the limit set by you.

Another major reason for setting stop loss is the trader’s mindset and discipline. Many times in a trade, the price of the stock comes to the limit set by you and you also have a chance to get out of it, but due to our greed and the expectation that the price will recover again, we do not place the order and we lose as much as we can. There was a fear that he would suffer huge losses. Therefore, it is very important to set stop loss here also because it brings discipline in our trading and mindset.

How to set stop loss?

Placing a stop loss order is as simple as placing a buy or sell order. In our trading platform we can easily place stop loss orders while taking or after taking a trade. Suppose you have bought 50 stocks of ABC company for Rs 100. You want that under no circumstances should you take a loss of more than 5%. In this case, you can place a stop loss order in two ways and these are the two main types of stop loss orders:

Stop Loss Limit – SL Price + Trigger Price

Stop Loss Market – Only Trigger Price

Stop Loss Limit: This type of stop loss order is placed with a trigger price and the trigger price should always be greater than or equal to the stop loss price (less in case of short selling). In the above mentioned case, if you want your stock to be sold at Rs 95, then for this you can keep the trigger price at 95.50. When the stock price comes to Rs 95.50, a sell limit order will be sent to the exchange and will be sold until it comes to Rs 95. The selling price can be between Rs 95.50 to Rs 95 or so but will not be less than that.

Stop Loss Market: In case of stop loss market only the trigger price needs to be set. You can place an order at whatever price you want to place the stop loss. For example, if you set a stop loss at Rs 95, then whenever the price hits Rs 95, the order will be sent to the exchange and your position will be closed at whatever price is in the market near Rs 95.

Stop Loss order strategy

Now we have learned why it is important to set stop loss and how to set stop and we also know how to calculate stop loss. While setting the stop loss, we have to keep in mind that it should be placed at a price where it does not hit the price movement caused by general volatility in the market. That is, the level where the loss in the trade is minimal and the order is not easily triggered. We can use two methods to determine the stop loss price. he is:

Percentage based

Support and resistance based

Percentage Based: According to this method we calculate the stop loss on the basis of a fixed percentage. That means how much percentage loss can we take in a trade. For example, if you have bought 100 stocks for Rs 500 and you want that you should not suffer more than 10% loss on it, then you can set the stock loss at the level of Rs 450. When the stock price goes below 450 or below, the stock will be sold automatically.

Sport and Resistance Based: Whenever you take a trade, you take it based on some pattern or price action on the chart. Such as the price breaking a resistance level or reversing from a support level. In these cases, you can place the stop loss around that sport or resistance level so that when the trade does not work as per your planning, the trade gets closed automatically. You can understand this through the chart given below.

Benefits of Stop Loss

The biggest advantage of stop loss is that it works to reduce the trader’s risk by keeping him within his loss limit. Because of this, it helps us to avoid sudden decline in the market or rapid losses. It also works to increase discipline in a trader. Without stoploss, the trader is unable to exit the trade at the right time or starts resorting to averaging, which is not good for both his capital and time. Stop loss helps us to work on a rule based mindset rather than following emotions in trading.

Disadvantages of Stop Loss

While stop loss limits your losses in trading, it can also sometimes turn your potential profits into losses. Many times, due to high volatility in the market, the stock price first hits your stop loss but later goes higher than the target price. In such a situation, no matter how correct your strategy or trading plan is, due to having a fixed stop loss, you end up incurring losses instead of profits.

Conclusion

Use of stop loss plays an important role in protecting us from huge losses in trading. New traders especially must use it. We will be successful in trading only when we have capital for trading and hence it becomes necessary for us to protect the capital from loss. Although stop loss does not guarantee that you will always be in profit, it definitely helps in maintaining our profits.