What is Stop Loss?
What is Stop Loss in Share Market?
Since the market conditions are subject to various fluctuations in prices of securities, investors need to constantly monitor their purchases to avoid high losses. In order to limit their losses, investors place a stop loss order with the broker where the brokers are instructed to sell an asset when it reaches a particular price point. Stop loss is also known as stop loss order or stop market order. This order is placed with a broker by an investor by paying a brokerage fee. It can be done for both short term as well as long term trading.
“The stock market is down; the stock market is up.” Is this something new to you, then you are probably a beginner in the stock market?
To understand this better, let us use an example:
Suppose an investor, Reena buys 100 shares of XYZ company ltd. Of Rs 50 each i.e., she invests Rs 5000 in the company. Due to fluctuations in the market conditions, the price of the security starts falling. In order to manage her loss, Reena places a stop loss order with her broker of Rs 45. The broker would sell the securities if the price drops to Rs 45 per share or below. Hence, the losses anticipated on selling of these securities is capped at Rs 5.
Further, if the price of such security jumps to Rs 65 per share then the investor would want to retain his profits and would prefer to set a stop loss order limit of Rs 55 per share. Hence, he can enjoy the gains from rise in prices and also limit his risk appetite.
Now, let us discuss the various types of Stop Loss in Stock Market order:
Fixed stop loss order –
This is the most common type of stop loss which is executed when a preset price of a particular security is hit. These stop losses can also be time bound to provide the position pre set amount of time to profit.
Trailing stop loss order –
In this stop loss order, the stop loss price is not fixed as a particular amount in Rs but specified as a percentage below market price. It even adjusts itself to the current market price ensuring that the investor receives capital gains and has limited risk as well.
Market order –
This is the most basic form of order where there is no prescribed limit by the investor and the broker is free to trade at prevailing market prices.
Limit order –
In this order, the investors prescribe the trade (buy or sell) of specific securities when the price reaches a predetermined value.
Now let us discuss the various advantages associated with stop loss order.
- No additional costs- Placing a stop loss order with a broker is similar to a free insurance policy as you don’t have to pay any additional fee for it. The usual brokerage fee is charged for trading when the pre-set price is reached.
- Minimum losses- Setting a stop loss order limit helps the investors to minimize risk associated with falling of prices and ensures that one stays within their risk appetite.
- Automatic- After setting a stop loss order limit, an investor does not need to constantly monitor and worry about their investments as the transaction will take place automatically when the predetermined price is hit.
Further, let’s discuss a few dis-advantages associated with stop loss.
- Short term fluctuations- One of the biggest advantages of stop loss is that it gets triggered even with short term fluctuations in the market. Hence, a margin should be kept to allow day to day fluctuations in price.
- Selling too soon- This is one of the risks involved as you may get out of trading in securities which would have been profitable later.