There are many things a trader or investors look before buying or selling the shares. Like current market price, return on investment the share can give, does fundamental and technical analysis. But many times it so happens that he forgets about a small little thing as stop loss order. This can make a huge difference in containing losses.
Stop loss order is an advance order, given to the broker/agent from trader/investor to sell the shares when it reaches a particular price. Usually, it is designed to limit loss on his position.
If one sets the stop order loss at say 10 percent, it means, when the share price reach is 10 percent below the purchase price it automatically triggers sell order.
Suppose share of XYZ Ltd. is purchased at Rs. 20 per share. And 10 percent stop loss order is placed. No sooner the share price reaches Rs. 18 the sell order will be triggered. And the share will be sold at the prevailing market price.
As far as share trading is concerned, stop loss has both advantage and disadvantage. The advantage is that once stop loss order is placed you do not have to monitor the share price on a regular basis. In this situation, you will not have to keep a constant watch on the market for a long period of time.
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The disadvantage is that if the share price touches your stop loss order for only a moment, your sell order will be triggered. No matter even if it is for a brief period.
Stop loss order percentage should be placed taking into account range of day to day fluctuation of the share. Since some shares show high/low volatility on daily basis. It can be 5 or 10 or even 15 percent. Depending upon, as the case may be.
Most people think that stop-loss order is just a tool only for preventing losses. It can also help to lock in your profits, sometimes called trailing stop. In this, stop order loss is set just below the current market prices. As the prices increases so does your stop loss gets adjusted to now 10 percent below new market prices. Using trailing stop, allows you to let your make profits while at the same time assuring some realized capital gain.
Taking the above example of XYZ Ltd., stop loss was 10 percent at current price that is Rs 18. Now suppose share price rose to Rs. 30. Your trailing stop loss order will be locked to Rs. 27 per share. Calculation – Rs. 30 minus 10 percent of Rs.30 that is Rs.27. In case of any downfall now, in the worst case, you will get Rs. 27 which is far above Rs. 18 that you might have received earlier.
You may be a value investor (seeking shares believing it to be undervalued) or growth investor (seeking shares for potential capital gains) or active trader (seeking shares to exploit profitable condition). Only one strategy works. And one must stick to it.
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