Stop-Loss Order
Active usage of a stop order during trading exchange operations makes it possible to enter the market on time, reduce the possibility of loss in ambiguous, uncontrolled situations, and control profits.
In this case, the request will be submitted for execution automatically. If the trigger price of the request is not reached, then it cannot be executed.
Experienced traders very rarely use stop orders to enter the market. Most often, a stop order is used to close a position under certain conditions. One of the special types of stop orders is a stop-loss order.
For example, a trader purchased shares of company A at $100 apiece, expecting them to grow, but negative industry news caused the market to move against the trader, and stock prices began to fall. The investor had a personal investment plan, according to which the allowable losses were taken into account in the amount of 5% of the funds invested by him. Losses can be limited by setting a stop-loss order at $95. If the price drops to $95, a stop-loss order will be triggered and the shares will be sold.
Under ideal circumstances, losses will not exceed the threshold value. But due to the peculiarities of the stop-loss order, the order can be executed only partially or at a price worse than the trigger price. In this case, the trader will suffer greater losses than he originally planned.
Benefits and Implications of Stop-Loss Orders
The benefits of a stop-loss order include the following points:
- Loss limitation. By setting a specific price for selling an asset, a stop-loss order allows you to reduce the potential losses of a trader. Using a stop-loss order is very useful in volatile markets, as prices can change rapidly.
- Automation. A stop-loss order allows you not to constantly monitor the price of an asset. When the price reaches the stop-loss limit, it will be executed automatically. This allows you to save both time and the nerves of the trader.
- Control of emotions. Trading on the stock exchange is an emotionally difficult task. If you define a point of sale strategy in advance and set a stop-loss order, you can prevent a panic sale or, conversely, holding an asset for too long.
- Risk management. Stop-loss orders are important for managing trading risk. By setting in advance the maximum loss that you are willing to accept, you can better manage risks and prevent significant financial losses.
- Flexibility. Stop-loss orders can often be adjusted in accordance with changes in the market or in the trader’s investment strategy, which will allow timely reduction of possible losses in case of price fluctuations and ensure profit.
- Economic efficiency. Using a stop-loss order does not usually require any additional costs.
- Exit strategy. A stop-loss order allows determination of the exit point in advance.
The implications of using a stop-loss order are:
- Market volatility and lack of guarantee of the exact price.
- Psychological impact. Sometimes the usage of a stop-loss order can lead to incorrect decisions. For example, the stop price may be set too close to the purchase price, which will lead to closing the position ahead of time.
- Potential for manipulation. There is a potential for price manipulation in less liquid markets.
- Difficulty for beginners. The system of using a stop-loss order for a beginner can be complicated and confusing.