Stop – Loss Order
There are three common types of orders. A market order, limit order, and stop-loss order.
Market order – Market order is an order to buy or sell a security immediately. This order will not guarantee the execution price but will definitely guarantee the time of execution. It will generally execute at or near the ask or bid price.
Limit order – Buying or selling a security at a specific price or better is known as a limit order. Buy limit order and sell limit orders will only be executed at the limit price or higher and limit price or lower respectively.
Stop-loss order – It means an order to buy or sell a stock once the price of the stock reaches the specified price, known as the stop price. A stop order becomes a market order when the stop price is reached.
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What are Stop-Loss Orders:
A Stop-loss order is an order done with the broker to buy or sell a certain stock when the stock reaches a certain price. This is basically designed to limit an investor’s certain loss. For example, setting a stop-loss order for 10% below the price at which you bought the stock will limit your loss to 10%. The stock is executed at the next available price when it falls below the stop price and becomes a market order.
There are 2 types of Stop-Loss orders:
- SL order (Stop-Loss Limit) = Price + Trigger Price
- SL-M order (Stop-Loss Market) = Only Trigger Price
- SL-M order – You will place a Sell SL-M order with a trigger price of 95. Here, when the price of 95 is triggered, a sell market order will be sent to the exchange and your position will be squared off at market price.
- SL order type – You will place a Sell SL order with price and trigger price. Since your order needs to be triggered first, the (trigger price ≥ price.) Here, this order type gives you a range of the Stop-Loss.
- Setting a stop-loss order for 10% below the price at which you bought the stock will limit your loss to 10%. Suppose you just purchased a stock at $20 per share. Right after buying the stock, you enter a stop-loss order for $17. If the stock falls below $17, your shares will then be sold at the next market price.
- If a trader has bought a stock at $2 a share and the price rises to $5 a share, he might place a stop-loss order at $3 a share, locking in $1 per share as profit.
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Why traders use stop-loss orders?
One of the main reasons for buying a stock with this order is that it charges nothing to implement except the commission. The commission is also charged only when the stop-loss price has reached and the stock should be sold. This order is kind of a free insurance policy. The advantage of these Stop-loss orders is that they can help you stay on track. One of the main purposes of this order is it reduces risk exposure and makes trading easier.
Many investors fail to use stop-loss orders effectively even though it is very simple to use. Whether to prevent excessive losses or to lock in profits, nearly all investing styles can gain benefit from this tool. Think of a stop-loss as an insurance policy that you hope you never have to use, but it’s good to know you have the protection should you need it.
Author – Saachi Lodha
About the Author – A passionate professional with knowledge of Accounting and Finance and currently exploring Financial Risk Management (FRM) to gain knowledge and exposure. As a part of FRM course also writing blogs to explore the field more and deep dive into the content.