What is Stop Loss in Share Market?
The stock market is a high-risk, high-reward investment opportunity, and investors must exercise caution while making investments. One of the key concerns of investors is the protection and minimization of their losses. This is when the Stop Loss comes into play.
Stop Loss is a trading strategy that is intended to restrict an investor’s loss on a certain stock. In layman’s words, it is a fixed price at which the investor decides to sell the stock in order to avoid additional losses. In this blog post, we will help you understand what is Stop Loss in the share market, and what are its types, advantages, and disadvantages.
What is Stop Loss in Trading?
Stop Loss trading is a method that investors use to restrict their losses on a certain stock. It is a set point at which the investor decides to sell the stock in order to avoid additional losses. Stop Loss trading is an effective instrument for stock market participants wanting to protect their investments.
How Does Stop Loss Work in Stock Market?
A Stop Loss order is one that an investor places with their broker. The order asks the broker to sell the shares at a certain price point. The price point is established by the investor and is generally lower than the current market price.
The order is activated when the stock price hits the Stop Loss price, and the broker sells the shares. This protects the investor against severe losses if the stock price falls below a specified threshold.
For example, if an investor purchases a stock for ₹100 and sets a Stop Loss at ₹90, the broker will sell the asset immediately if the price falls to ₹90 or less. The investor’s loss will thus be limited to ₹10 per share. If you wish to learn more about Stop Loss, you can pursue a stock market trading course.
Types of Stop Loss Orders
There are several types of Stop Loss orders that investors can use while trading in the stock market. These include:
- Market Orders- When the Stop Loss price is reached, the broker is instructed to sell the shares at the current market price.
- Limit Orders- A limit order asks the broker to sell the stock at a certain price. This indicates that the investor will only sell the shares if the price falls below the stated limit.
- Trailing Stop Orders- This is a conditional order that enables investors to specify a dynamic Stop Loss level that adapts to the fluctuating price of an asset. By allowing investors to lock in gains when the price rises in their favor and offering a mechanism to restrict possible losses if the price starts to decrease, it is intended to safeguard profits.
It is important to note that Trailing Stop Orders are identical to ordinary Stop Loss orders, but the Stop Loss price changes in tandem with the stock price. As a result, the investor may lock in profits while reducing losses.
Advantages of Using Stop Loss in Share Market
Stop Loss orders are a significant tool used by investors in the stock market to minimize their losses and control their risk. Out of the many advantages of Stop Loss in the share market, we have listed down a few of the important ones below:
1. Keeping Losses to a Minimum
When an investor places a Stop Loss order, they are implemented effectively indicating that if the stock price goes below a given level, they want to sell it. This helps to mitigate losses and protect the investor’s portfolio from further harm.
2. Protecting Gains
Stop Loss orders can also be used to protect gains. For example, an investor may buy a stock at a cheap price and then watch it climb consistently over time. They may, however, be unwilling to sell the stock if it continues to increase. In this case, the investor can place a trailing stop order to sell the stock if the price drops by a particular amount. This helps to secure the investor’s earnings by locking in profits.
3. Risk Administration
Stop Loss orders can assist investors in maintaining discipline and sticking to their investment plans during periods of market volatility.
4. Taking Emotion out of Trading
Stop Loss orders aid in the removal of emotions from trading, allowing investors to make reasonable decisions based on market conditions and predefined levels. This helps to avoid rash judgments based on fear or greed, which can harm an investor’s portfolio.
Disadvantages of Using Stop Loss in Share Market
Handling stocks comes with risks itself, and so also the Stop Loss orders. Here are some of the risks that you would be undertaking while using Stop Loss orders:
1. Triggering a Sell-off
If a significant number of investors place Stop Loss orders at the same level, the stock price may fall fast, resulting in a sell-off. This might lead the stock price to drop below the Stop Loss threshold, resulting in investor losses.
2. False indications
Stop Loss orders can potentially produce misleading signals, causing investors to lose money. For example, if the stock price goes below the Stop Loss threshold as a result of a momentary market movement, the order may be activated, resulting in unneeded losses. This is especially troublesome in turbulent markets, where prices may change quickly.
3. Lack of control
When the order is activated, the stock is automatically sold without the investor’s intervention. This can be difficult for investors who wish to keep control over their assets, and it might lead to lost opportunities.
4. Slippage
Slippage happens when the order’s execution price departs from the Stop Loss level. This might occur as a result of market volatility, liquidity problems, or other circumstances. Slippage can cause investors to lose money since the price at which the stock is sold may be lower than the Stop Loss level.
5. Trading at a High Frequency
High-frequency trading (HFT) can potentially be hazardous to investors that use Stop Loss orders. HFT algorithms can identify and manipulate the market to trigger Stop Loss orders, resulting in a sell-off and possibly large losses for investors.
Conclusion
Now you know what is Stop Loss in the share market. It not only helps to reduce losses, but it also assures that investors do not make emotional trading judgments. A Stop Loss order is one that an investor places with their broker that advises the broker to sell the stock at a predefined price point in order to avoid additional losses.
