Stop-loss Order: Meaning and Definition

There are traders who are well versed in the financial activities related to the stock market and other such things make the most of these tools to enhance their profits. Many of you might not be experienced and may have just forayed into the world of finance. A stop-loss order is a popular tool numerous traders use to achieve their targets. Some may have come across this tool, and some may be wondering now, What is stop loss? What is the Stop loss definition? What is Stop Loss meaning?

What Is Stop Loss In Stock Market?

Stop Loss definition: The stop-loss order limits the classes of investors and traders and is very helpful in reducing risk exposure. There exists a large number of things to take into consideration while deciding to buy a stock or leave it. The stop-loss order can make a massive difference if appropriately used. It is a type of order placed with your broker to buy or sell talks once they reach a specific price point. An investor exits a trading position held by him if the stock price reaches a particular level, indicating a certain amount of loss. 

The stop loss tool essentially reduces the losses on an investor or trader’s specific position of security. Let us take one example to understand this better. Suppose an investor holds 300 shares of a particular stock. He sets a stop-loss order for below 15% off the stock price. The stock price at the time of his purchase was Rs. 200. Due to some unforeseen reasons, the stock price starts falling sharply. Now, if the stock price goes down below Rs. 175. The stop loss executes the order to sell the shares automatically at the current market price. It will result in a net loss of Rs. 25 per share. It is the maximum amount of loss that can occur on each share. 

How to Find Stop-loss Level?

So, you know about stop-loss meaning. Let’s discuss how to find its level to understand what is a stop loss in the stock market. Setting the correct price is crucial to making the best out of the stop loss tool. Only this can give you an edge in proactively reducing your losses. One can take the following into account while setting the stop-loss levels.

i) Moving averages, the 50-day moving average DMA, 100 DMA, and 200 DMA can help identify the stop loss level.

ii) The technical indicators light relative strength index (RSI)and moving average convergence divergence (MACD) and their crossover levels. 

iii) Trendline support that indicates the rise or fall support. You can use it as a stop-loss price. 
Now that we have a clear picture of stop-loss and understand how it works, let’s look at the different stop-loss orders. 

Fixed Stop Loss

The fixed stop-loss order gets activated when the stocks arrive at a predetermined price. When he opens the trade, one has to place the stop loss order right at the beginning. Traders mostly keep it there but move it to break even if the market goes in their favor. The whole idea behind the fixed stop is that as it does not respond to the market, you will thus allow it to run till the very end of the trade.  It is also possible to operate the fixed stop loss best. 

It is also trendy among many traders. The time-bound fixed stop loss is beneficial to those investors who want to give their position a predetermined amount of time to profit before moving ahead to the next trade. 

Trailing Stop-loss Order

Traders usually enhance the efficiency of a stop-loss order by coupling it with a trailing stop. There is no fixed price as a numerical value or an absolute amount in the trailing stop-loss order. Instead, it is based on a certain percentage of the total value of an asset’s price. The order to sell gets activated only when the asset price falls below the stipulated price set. As the price of the set increases, it automatically moves the stop order alongside it. When the price stops rising, the new stop loss remains at the level. 

Thus, it helps the investor accrue the profits when the price attains new heights. In a trailing stop loss, the order is set for execution if the asset price goes below 5% of the prevailing market value. If the asset price is Rs. 200, the order to sell the particular asset gets automatically executed by the concerned broker as soon as the price touches the 190 mark. 

Now, in an increase in the asset’s value, the stop loss level also increases. For example, it reaches a level of Rs.240. The trailing order will now stand at 5% of the new current market value of rupees 240. The stop-loss order will get executed at 5% of Rs.240, i.e., Rs. 228. In this way, the stop-loss order allows the investors to enjoy the capital gains made apart from saving them against unexpected erosion in the price of assets.

Advantages of Stop-Loss Order

A stop-loss order can hugely benefit by limiting the extent to which the investors incur losses and can be beneficial in the following ways.

Reducing the Loss

A stop-loss order helps investors and traders to cut short their losses. It thus prevents any significant loss in the stock market while trading. There are quite a several instances where the price takes a nosedive. It can result in a pretty unpleasant experience. Such a stop-loss order is quite helpful.  

Automation

The automated mode of functioning makes stop-loss a very assistive tool. It rescues you from the need for continuous monitoring of the portfolio. The stop-loss triggers when the asset reaches the set price, making the whole process relatively simple.                                 
Helps Maintain the Balance Between Risk and Reward

It is an essential part of investing in managing the risks and gains. It becomes even more crucial while trading. It is always wise to calculate the amount of risk to achieve a specific reward. Stop-loss orders help fix the percentage of price fluctuation you can afford to tolerate. Hence the risk balance and rewards.

Promoting Discipline

Investors need to be highly strategic and plan their investments according to their profile. They should stick to those plans and not stray away from them. The stop loss helps to remain with the strategies made. It inculcates and enhances discipline in trading.

Frequently Asked Questions (FAQs)