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A stock market is a place where investors and traders buy or sell company stock in order to build a financial portfolio. The stock market is a highly volatile field, and trading in the same can be risky. There are many scenarios where traders use a short selling strategy on a stock that goes against the trade, and sometimes it becomes hard to exit the trade without a stop loss strategy.
Traders who are new to trading, especially day trading, might assume that it is easy to trade and invest in stocks. However, if traders are not cautious and educated about how to handle market situations to their advantage, they may suffer losses. Therefore, in order to mitigate such market risks, one needs to understand risk-mitigating parameters such as stop loss order. Using a tool like stop loss can save one from huge losses. In stop loss calculation, traders identify the risk and take necessary precautions to avoid the risk. Let’s understand what stop loss is and how to calculate it.
Stop Loss Trading in Stock Market
A stop loss is an innovative and powerful tool that is available to traders to curb losses and absorb the pain of constantly following a trade. It is an advance condition for one’s trade order, which helps traders save time and effort.
In simple words, stop loss trading is used to automate the price of selling in different market situations. It is a tool offered by the majority of brokers to add conditions and actions to the following trade. Traders can use stop loss tools for both short term as well as long term. They find this tool handy and practical for handling their traders.
One can understand the use of stop loss through this example. A trader named Mohit holds a stock bought at ₹100, and he places a stop loss order at ₹80. In the following few hours, the stock price falls to ₹79.66. Since Mohit has placed the stop loss order, the stop loss order is triggered, and his position is closed automatically to avoid losses because the stock price fell below ₹80. However, if Mohit hadn’t placed a stop loss order, he might have suffered more losses when the price went down below ₹80.
Day Trade and Stop Loss Order
One can assign a stop loss order to one’s broker to sell and square off one’s trading position when the stock reaches a specific price point. Having a stop loss for intraday trading lets one completely control losses on each trade one makes during intraday trading. As a professional or a beginner day trader, it’s good practice to keep a stop loss order to mitigate risk. Stop loss orders are really a good luxury tool for passive traders. It lets traders monitor and plan other trades or tasks rather than overlooking the trade they have already placed in the stock market. If one has other tasks or trades that one can prioritise, check all one’s intraday trades afterwards.
Types of Stop Loss Orders
There are two types of stop loss orders, as explained below:
A Fixed Stop Loss Order
A fixed stop loss order is triggered when an investor has set a predetermined price. Time based stop loss orders are also commonly used until the trade is placed. This type of stop loss order is used by investors who want to trade at a predetermined price.
Trailing Stop Loss Order
A trailing stop loss order provides additional protection to an investor while providing a boundary against the unexpected downtrend. This order is set upon the percentage of the total price and the order to sell if the market falls below a particular level. However, when the share price increases, the trailing order instantly adjusts to reflect the entire increase in the market valuation.
Calculation of Stop Loss Using the Support Method
Stop loss can be set using the support method. Traders must be clear about support price level and resistance level. The support level price is the price below which the stock price doesn’t fall. The resistance level price is the price above which the stock price doesn’t rise. Suppose the support level of a stock is ₹600 and the resistance level is ₹700. So, the trader can put a stop loss within support and resistance level prices as they are good indicators for determining stop loss. In this particular example, it would be advisable to put a stop loss order at ₹650.
Mistakes to Avoid When Placing Stop Loss
Setting a stop loss is critical, but doing it correctly is even more critical. Traders might place stop loss orders very close to the current price, which may lead to squaring off their positions way too soon.
A second mistake that traders might make while placing a stop loss is to put it at support or resistance levels.
The third mistake can be not adjusting the stop loss order according to the change in the value of the stock. There is a per cent rule that can be used to set the value of the stop loss order. Usually, traders who want to avoid heavy losses can look for a stop loss order with a certain percentage, for example,10% below the stock purchase price.
One can understand this with an example. Suppose a stock is worth ₹100 and stop loss is set at 10%, that will be at ₹90. Hence, if the stock falls below ₹90, stop loss will be triggered, and the position will be squared off automatically. This method helps traders to adjust the stop loss limit with an increase or decrease in stock price. So, if the price rises to ₹120, the stop loss order limit will get adjusted and will be set at 10% below the stock value, which will be at ₹108.
Other than this, there is also a swing low and swing high strategy. In this strategy, stop loss orders are accurately placed at a point where the trend is expected to bounce back from a downward or an upward stock trend, which can be marked as a V-shape. Here, in the high swing strategy, traders place a stop loss order at a slightly higher price than the selling price to ensure there are no higher losses.
Conclusion
Having a stop loss strategy is like having a colleague with whom one can share one’s work. With a stop loss strategy, one’s existing trading strategy can be automated without any supplementary cost or sophisticated method. It is a great option, and it is a personal choice for day traders whether to use the stop loss strategy or not. A trader who actively takes intraday trades and is often hungry to grab trading opportunities follows the stop loss activity for better outcomes.
Although a stop loss is a great tool, there is still an important question of how to use a stop loss in intraday trading. To answer this question, one needs to try placing stop loss orders using different strategies and get expert opinions about the usage of the stop loss trading tools.