Understanding Stop-Loss Orders in Detail

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Stop-Loss Orders

From a low of less than 8000 in April 2020, the Nifty rallied to more than 18,500 in October 2021. Many investors made much money during that phase when the Nifty rose to an all-time high. What is Nifty, you may ask? The Nifty is an index that measures the overall stock market performance. Looking at the lucrative gains of investing in shares, many people, who had never invested before, opened their Demat accounts and invested in shares. Some even took it a step further and have turned into full-time traders. However, it is easy to make money when the entire stock market is trending upwards.

In contrast, as of June 2022, the Nifty has paused its upward trajectory, and it hovers between 15,000 to 16,000. During such times, your ability to manage risk will help you make returns and preserve your capital. Proper risk management is essential whether you are an investor or trader. It is exceptionally paramount when the positive sentiments in the market start declining. One simplest yet most effective way to manage risk is to place A stop-loss order.

What is a Stop Loss Order?

A stop-loss order is an order you place as an investor to sell a specific stock if the stock reaches a particular price. The main reason you would place a stop-loss order is to limit your losses. If you are a trader, you will exit your long or short positions at a specific price by placing a stop-loss order. A stop-loss order is probably the most crucial tool that helps maintain discipline and preserve capital.

For example, let us say you invested in the stock of Reliance Industries. You purchase shares of Reliance at Rs 2,500, expecting the stock price to increase soon. After analysing the stock, you conclude that you will not be comfortable holding the stock if the price falls below Rs 2,450. So you place a sell stop-loss order at Rs 2,450. If the price touches Rs 2,450, your stop-loss order will activate. In case you have a short position, you place a buy stop-loss order.

How to Place a Stop Loss Order?

Brokers like IIFL Securities provide you with the feature to place a stop-loss order when you buy or sell (short) shares. When you buy shares, you place a sell stop-loss order. That is because you expect the price to rise, but if it falls, your sell stop-loss order will activate and limit your losses. Likewise, if you sell shares or have a shorting position, you place a buy stop-loss order. Since, in the event the price rises, you would want to limit your losses.

In either case, you have two choices: A stop-loss limit market (SL-M) order and a regular stop loss (SL) order. In the case of an SL-M, the price of the securities touches a certain level and triggers your stop-loss order. The order is then sent to the exchange and executed at the market price.

In the case of a regular stop-loss order, you set a stop-loss trigger price and a limit price. So, Suppose you set the trigger of your sell stop-loss order at Rs 95 and the limit at Rs 94. Your stop order will get triggered if the price touches Rs 95, and the order will go to the exchange. However, the order will not get executed under Rs 94. You decide your stop loss level by analysing the stock from a technical perspective.

Importance of Implementing a Stop Loss

Only a disciplined trader can become a successful trader. A disciplined trader should be able to rotate their capital, book timely profits and minimise losses. By minimising your losses, you exit your positions and can use your capital to seek a profitable trade elsewhere. You can let go of a position before it is too late by implementing a stop loss in your trade. It will encourage you to find better trading opportunities instead of losing your capital on a failed trade. Hence, as a trader, it is integral that you always place a stop-loss order when you are trading.

When you set your stop-loss order, apart from the technicals of the stock, also factor what is Nifty 50’s chart reads. By doing this, you can gauge the overall market conditions. If the market is very volatile, it is better to trade with a conservative stop loss.

If you are a long-term investor, you can also invest, keeping a stop loss in mind. If the price of the stock you have invested in falls below the stop-loss price. You can consider selling the stock. As a long-term investor, you analyse the company’s fundamentals and construct an investing thesis basis on which you make your investments. However, as a retail investor, there are limitations beyond which you cannot retrieve information on a company. So, there are cases where the stock price plummets before you can identify the red flags. In such a case, investing with a stop loss helps.

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