Home » What are a stop loss and a trailing stop loss?

What are a stop loss and a trailing stop loss?

What are a stop loss and a trailing stop loss?

Photo courtesy mohamed_hassan on Pixabay.

People enter the stock market to make money. The motive may be different for everyone; some may be there for making money in the short term while others want to make money in the long run and yet others prefer to make money from the stock markets on the side i.e. along with the job or business they are doing.  Stop loss is important and individuals should be aware of its importance.

Stop loss is more important for traders. There are people who want to be full-time traders and make their livelihood through the stock markets. But the success ratio of traders is very low and most of those entering the stock market as traders lose money in a year or two.

Individuals should be very careful about protecting their profits and cutting down their losses. A stop loss is an order that is placed with a broker to exit a stock when it reaches a certain point. When the stock reaches the stop price it becomes a market order and the trade is executed at the next available opportunity.

A stop loss can be used when a trader or an investor doesn’t want to be present in front of the trading screen the whole day and the trade gets triggered when the set price is reached. This is very helpful for small traders and investors.

We will try to understand this with an example. Suppose you purchase the stock of a company XYZ at Rs. 5oo and expect the price to move higher. But it may be that the stock price may not perform as expected and start falling and you may not be present in front of the trading screen. This is where you can put a stop loss and limit your losses. The order will be immediately triggered at the stop loss price if the trade does not work out as planned. For a Rs 500 stock if you have put a stop loss at Rs. 495 the position would be automatically squared off at Rs. 495 thereby in the process reducing your losses.

There are no set rules for placing a stop loss. You can instead work out the percentage on the stop loss instead of the rupees stop loss. Like the Rs 5 stop loss may not be the best choice for every stock. Instead, you can keep a 2% stop loss. For a stock of Rs 3000, the 2% stop loss will be Rs. 60 and for a stock of Rs 200, a 2% stop loss will be Rs. 4.

The stop loss can even be placed at the support and resistance levels.  When you have purchased a stock the stop loss can be placed near the support zone of the stock.

There are many advantages of using stop loss:-

  • It helps to manage the risk in a trade.
  • It does not cost a dime to place a stop loss. A regular commission is charged once the stop loss order is carried out.
  • You may not be present in front of the screen the whole day and may be busy with your job or business or may even be on a vacation. In these cases, you don’t have to monitor the stock movement continuously.
  • Some people may not be able to take sell decisions at the right moment. Stop loss insulates people from all emotions. This brings discipline to trade and an individual is able to stick to their strategy.

Trailing Stop Loss-

A trailing stop loss is used to protect the profits. Trailing stop loss can be placed both in percentage as well as in rupees.

Let us consider an example- Suppose you purchase a stock at Rs. 1000 and its price rises to Rs. 1015. There are brokerage reports that say that the price would rise further and you believe that the price would move up. In this case, you can place a trailing stop loss of Rs. 5. When the share price moves to Rs. 1020 the trailing stop loss would be shifted to Rs. 1015. When the price of the share falls to 1015 after reaching a high of Rs 1020 your stock would be automatically squared off at Rs. 1015. The trailing stop loss ensures that your profits are protected up to a point and you don’t end up losing all the gains you have made.

Now that we have discussed the stop loss it would have become clear how to protect your capital and with the help of trailing stop loss, you can protect your profit. The stop loss helps to protect your capital and you can survive in the game for a longer period of time. People should not hesitate to use stop loss and even successful traders and analysts use stop loss in their trades.

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