When deciding or contemplating about a stock buy most traders tend to forget to pay attention to the little factors in the trade that have the ability to make or break them. The stop loss order is a perfect of example of such a thing; it is a tool that when used effectively can be beneficial to anyone for various different reasons.
What Is a Stop-loss Order? A stop-loss order can be defined as an order that is made with an agent or broker to either buy or sell the stock as soon as it hits a specific price, this is done to do as much damage control to the loss of the investor’s as possible in a small time gap. For example, if you set the stop loss order at 5% percent less than the price you bought your share at, the stock will limit your loss to just that 5% and not any more than that and as soon as at it hits that low, your share will be sold at the going price in the market.
Advantages of a Stop-loss OrderHowever, no commission price is charged until the stop-loss order has been reached and the stock is ready to be sold, this makes it very much similar to a free insurance program, now you can’t tell me that that doesn’t sound like the best thing in the world.
Furthermore, a stop loss order makes financial decisions quite free from emotional influences, now this may sound foolhardy but people do often fall in love with stocks, and tend to delay selling them, this can prove to be very disadvantageous to the trader, the whole point of being a trader is to sell and sell on profit, not using the right strategy takes away from that and clouds your judgment.
Another advantage of the stop-loss order is that you save a lot of your personal time as because of it, you don’t have to spend time monitoring how the stock is doing on a daily or hourly basis. You can be safe in the knowledge that you will not go into any permanent loss that you won’t be informed of while you’re away on vacation or held up at work, if you’re a part time trader.
You need to understand that stop- loss orders will not confirm all you profits, you can’t simply make a stop-loss order, lean back and relax and expect the money to start flowing in, you will still very much need to make good decisions regarding your trade, if you don’t you’ll most definitely lose the same amount of money you might have lost without a stop-loss order, granted that the incurring losses process will go a bit slower. So the only thing stop-losses can do for you if you neglect all other factors of being a successful trader is buy you some time.
Disadvantages of Stop-loss OrdersThe downside of stop-loss orders is that the stop price could quite easily be activated by a short term variation in the stock’s price. It would be foolish to set a 10% stop loss on stock that has a tendency to fluctuate by 20% in a week or even on a daily basis.
Trailing StopContrary to popular belief, stop-loss orders aren’t just used to prevent losses, they are also used to locking in the profits that are made- this process is also known as ‘trailing stop’ it involves the trader placing an order to set the stop-loss at the current market price rather than the price below at which you bought it, this price adjusts itself with the ups and downs in the stock price. Using the ‘trailing stop’ method allows the trader to have profits and a guaranteed capital gain.
All in all, despite the fact that not many traders make use of this constructive tool, it is one of great usefulness and a good trader should employ as many of these trading tools as he can.
