Why is a stop-loss order important for trading? learn tips

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Why is a stop-loss order important for trading? learn tips

Who wants to lose money while trading on the market? Of course, no one. However, the market is not always easy to predict, and you might sometimes face brutal outcomes while trading. Analysts and economists have created several must-use tools and strategies to minimize the loss while trading and one of these essentials is a stop-loss strategy.

Nevertheless, many investors find it challenging to determine where to set their stop-loss level. If the market moves in the opposite direction, putting the stop-loss order too far can cause huge losses. However, if you place your stop-loss too close, you may exit the position too quickly.

So how do you know where to place a stop-loss order? Read on to learn more.

What is a stop-loss order?

A stop-loss order is placed to a broker. Once the stock reaches a certain price, you can buy or sell a specific stock. The stop loss is designed to limit investors’ losses in securities positions.

For example, setting a stop-loss order to be 10% lower than the price you purchased the stock will limit your loss to 10%. Suppose you just purchased Microsoft stocks for $20 per share. After buying the stock, you immediately enter a stop-loss order of $18. If the stock drops below $18, your stock will be sold at the current market price.

Stop-limit orders are similar to stop-loss orders. However, as their name says, the price they will execute is limited. Two prices are specified in the stop-limit order: the stop-loss price, which converts the order into a sell order, and the limit price. A sell order will not become a market order but a limit order, which can only be executed at the limit price.

What to consider for stop-loss orders

As an investor, you need to keep the following points in mind when it comes to stopping loss orders:

  • Stop-loss orders are not suitable for active traders.
  • Stop-loss orders do not apply to large stocks because you may lose more in the long run.
  • The broker charges different fees for different orders, so please pay attention to your payment amount.
  • Never assume that your stop-loss order has passed. Always wait for order confirmation.

How to determine your stop-loss order

It is determined that the placement of a stop-loss order is based solely on the allowable risk threshold. This price should be strategic, and the purpose is to limit losses. For instance, if you purchase stock worth $30 and your stop-loss is set at $24, the stop loss will limit the downside capture to 20% of the original position. If the 20% threshold makes you comfortable, set a trailing stop.

Before you start trading particular security, know where you will place your stop loss.

There are many theories about stop-loss settings. Different stop-loss or limit orders have other uses depending on the type of timing technology implemented. Some theories use standard configurations, such as a 6% trailing stop for all securities, while some views use security or mode-specific configurations, including average actual range percentage stop losses.

Why should you set stop-loss orders?

The most important benefit of a stop-loss order is that it does not require any implementation costs. You will only be charged a regular commission when the stop-loss price is reached, and the stock must be sold. Think of a stop-loss order as a form of a free insurance policy.

Another benefit of stop-loss orders is that it allows decision-making to be unaffected by any emotions. For example, they may maintain the false belief that it will appear if a stock is given another chance. This delay may only lead to increased losses.

No matter what type of investor you are, you should quickly determine why you hold stocks.

The standards of value investors are different from those of growth investors, which are different from active traders.

The most important tip is not to choose the best method but to stick to your selected plan and don’t give up in the middle of the way.

Therefore, if you are a hard-core buy-and-hold investor, your stop-loss order is almost useless.

Helpful stop-loss placement strategies

Standard methods include the percentage mentioned above way. There is also a support method, which involves a hard stop loss at a fixed price. This method may be a bit difficult to practice. You need to find the latest support level for the stock. Once you figure this out, you can place the stop-loss order below that level.

Another method is the moving average method. By using this method, the stop loss is located below the longer-term moving average price rather than the short-term price.

Swing traders usually use a multi-day high/low method, where the stop-loss is located at the low price of the scheduled day trade. For example, lows may always be replaced with two-day lows.

More patient traders may use indicator stoplosses based on larger trend analysis. Indicator stop loss is usually combined with other technical indicators, such as the Relative Strength Index (RSI).

Bottom line

After all, if you want to be a successful investor, you must have confidence in your strategy. This means carrying out your plan. The advantage of stop-loss orders is that they can help you stay on track and prevent your judgment from being overshadowed by emotions.

In the end, traders need to realize that stop-loss orders do not 100% guarantee high profits in the stock market. Except for correct stop-loss orders, you still need to make smart investment decisions. If you don’t do this, you will lose as much money as without a stop-loss.

Always use a stop-loss and check your strategy to determine the appropriate place for the stop-loss order. According to different approaches, the risk points of each transaction may be different. That’s because the stop-loss should be strategically set for each trade.

Overall, setting the stop-loss correctly is an essential skill for any trader. We hope our article gave you a better understanding of its importance and usage. We wish you a successful trading experience.

 

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