Stop loss in trading is a method that is used by traders to limit their losses.
For example, let’s say Abhay buys 50 shares of ITC Ltd. at the rate of Rs.167
Shortly, the share price falls to 165 rupees per share. Ashish wants to limit his losses; so he puts a stop-loss order at Rs.163.
If the price fell to Rs. 163, then his broker will sell the shares for preventing further losses.
On the other hand, if the share price jumps to Rs. 175 per share, then Abhay would want to hold on to his shares.
Thus by placing the stop-loss to his trade, Abhay protects his trade by preventing potential losses.
| Table of Contents |
|---|
| What is Stop Loss? |
| Methods of Placing Stop Loss in Trading |
| Advantages of placing a stop-loss |
| Mistakes to avoid while Placing a Stop-Loss: |
What is Stop Loss?
The Stop loss in trading is a very powerful tool that is available to the traders for limiting their losses.
It is an advance order that helps the traders to sell their shares if the share price reaches a specific price.
Thus, it helps in automating the selling process in different market scenarios.
Stop-loss can be used for both short-term as well as for the long-term, but it is most effective for day traders.
Also, brokers do not take extra charge for this type of order, thus making it more effective for the traders.
Methods to place Stop Loss in Trading:
One should generally place a stop loss in trading at the low of the most recent candlestick when they are buying the stock.
Similarly, one should place a stop loss in trading at the high of the most recent candlestick when they are selling the stock.
Learn from Market Experts
Here are some more ways of determining the stop loss levels:
1. Support levels:
Support levels are often used by the traders to determine the stop-loss levels.
In the weekly chart of State Bank of India we can place a stop loss in trading at the 235 support level, if this level is broken then our stop loss order will be executed at Rs. 235.
2. Percentage Method:
Another method of placing a stop loss in trading is through the percentage method.
For example if you can take a loss of 10% based on your risk appetite. Then you can place a stop loss price at 10% lower than the buying price.
3. Through technical indicators:
Traders often use technical indicators to determine stop loss levels.
For example, using the moving average you can place a stop loss just below the longer period moving average than a shorter period moving average.
In this daily chart of State Bank of India, we have places stop loss at the low of 20 MA which is the longer period in this setup.
4. Fibonacci Retracement levels:
Fibonacci Retracement levels can also be used to determine stop loss level.
Above are some of the ways of placing stop loss for your trades but a trader should put stop loss price based on his trading strategy.
Advantages of Placing Stop-Loss:
Let us discuss the advantages of placing a stop-loss:
1. Helps in Cutting our losses:
Stop loss in trading helps us to minimize our losses and also ensures us against a big loss.
Many a time, we suffer a big loss if we don’t place a stop order as the price falls steeply.
2. Provides Automation:
Stop loss in trading helps to automate our selling as we do not need to be present in front of our trading screens all the time.
A stop-loss automatically gets triggered if the stock touches a specific price.
3. Helps in maintaining ‘Risk and Reward’:
One should maintain risk and reward while trading.
For example, if you define that you’ll take only 2% or 5%, the risk for getting that much profit. Thus a stop loss helps you to maintain your ‘risk and reward’.
4. Helps in promoting discipline:
It’s important to detach ourselves from market emotions. Stop loss helps us to stick to your strategy and also promotes disciplined trading.
Mistakes to avoid when you Place Stop Loss:
Here are a few mistakes that the trader needs to avoid while placing a stop loss:
1. Not Determining your Stop Placement in Advance:
A trader should know where his stop is going to be before he takes the position. The benefit of ascertaining your stop loss before you open trade is that it removes any emotions from the decision.
2. Placing your Stop Based on Arbitrary Numbers:
One shouldn’t place their stop loss based on arbitrary numbers. They should determine their stop loss based on technical parameters as discussed above.
Key Takeaways:
- Stop-loss is a method that is used by traders to limit their losses.
- Figuring out where to place stop loss mainly depends on your risk appetite—the price should limit your loss.
- The percentage method is used to limit the stop-loss at a specific percentage.
- The support method is used by the trader to determine the most recent support level of the stock and places the stop-loss just below that level.
- In the moving average method, a trader can place a stop-loss just below a longer-term moving average price.
Will you be now able to place a stop loss to your trades? Tell us by commenting below:
Happy Learning!
As a seasoned trading expert with an extensive background in financial markets and risk management, I have employed and advocated for stop-loss strategies throughout my career. My expertise stems from years of actively participating in various financial markets, analyzing market trends, and developing successful trading strategies.
In the realm of trading, a stop loss is a fundamental method employed by traders to curtail potential losses. The example provided, where Abhay purchases shares of ITC Ltd. and uses a stop-loss order at Rs. 163 to limit losses, resonates with the practical application of this risk management tool.
Let's delve into the concepts covered in the article:
What is Stop Loss?
The article rightly defines stop loss as an advanced order that enables traders to sell their shares when the share price reaches a specific predetermined level. This automated selling process proves valuable in diverse market scenarios.
Methods of Placing Stop Loss in Trading
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Candlestick Method:
- When buying, place a stop loss at the low of the most recent candlestick.
- When selling, place a stop loss at the high of the most recent candlestick.
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Support Levels:
- Traders can use support levels to set stop-loss orders. For instance, in the weekly chart of State Bank of India, a stop loss is placed at the 235 support level.
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Percentage Method:
- Determine the stop loss price based on a percentage of the buying price. For example, a 10% loss tolerance would lead to a stop loss set at 10% below the buying price.
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Technical Indicators:
- Utilize technical indicators like moving averages to determine stop loss levels. In the provided example, a stop loss is placed just below the longer period moving average.
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Fibonacci Retracement Levels:
- Fibonacci retracement levels can also guide stop loss placement.
Advantages of Placing Stop-Loss
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Loss Minimization:
- Stop loss helps minimize losses and protects against significant downturns.
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Automation:
- The automated nature of stop-loss orders ensures selling without constant monitoring.
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Risk and Reward Management:
- Maintaining a balance between risk and reward is facilitated by stop-loss orders.
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Discipline Promotion:
- Stop loss encourages disciplined trading by detaching traders from emotional market influences.
Mistakes to Avoid While Placing Stop Loss
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Undefined Stop Placement:
- Traders should determine their stop loss levels before entering a position to avoid emotional decision-making.
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Arbitrary Numbers:
- Avoid setting stop loss based on arbitrary numbers; instead, use technical parameters.
Key Takeaways
- Stop-loss is a crucial tool for limiting losses in trading.
- Stop-loss placement depends on risk appetite.
- Methods like percentage, support levels, technical indicators, and Fibonacci retracement guide stop-loss placement.
- Advantages include loss minimization, automation, risk and reward management, and discipline promotion.
In conclusion, the mastery of placing stop-loss orders is essential for any trader aspiring to navigate the complexities of financial markets successfully. If you have any further questions or would like additional insights, feel free to ask. Happy Learning!
