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Day trading, also called intraday trading, is the trading approach that involves the buying and selling of financial instruments like stocks or derivatives on the same trading day. If you have done some research about day trading, you may already know that it is a high-risk, high-reward trading approach. Despite the high risk, the number of Indians who wish to start day trading is on an uptrend. However, along with the high-risk appetite, they are also willing to put in the effort to learn various day trading strategies to become better traders.
That said, most beginners who start day trading dedicate most of their time to learning trading strategies to make money. They fail to give importance to management, which will help preserve their capital. So, in this article, we will cover one of the core risk management strategies, which is the stop-loss trading strategy.
Stop-Loss Order in Day Trading
Before we learn about the stop-loss strategy in intraday trading, let us understand what a stop-loss order is. A stop-loss can simply be defined as a level or price at which you exit your trading positions to prevent further losses. Let’s make the concept of a stop-loss clearer with the following example. Suppose a trader buys 200 shares of SBI for ₹600 and expects the price to touch ₹615 by the end of the trading session. However, if the event the price does not move in the expected direction, they set a stop-loss at ₹595. Now, if the price touches ₹595, they exit their positions, booking a minor to avoid heavier losses.
Now that you’ve understood the concept of a stop-loss order, a stop-loss order is an order type provided by your broker so that you can pre-set the level at which you would like to place your stop-loss. So, if we go back to the above example, the trader could set a stop-loss order at ₹595. In the event the SBI’s share price touches ₹595, an order to exit the position will automatically be sent to the exchange. So, by implementing stop-loss trading, you can set a predetermined price at which your trades will close if the market moves against you.
Types of Stop-Loss Orders
Now, coming to the types of stop-loss orders. We have three main types of stop-loss orders. They are regular stop-loss orders, stop-limit loss orders, and trailing stop-loss orders.
- Regular stop-loss orders:
The example discussed earlier demonstrates this type of stop-loss order, i.e., an order of this type will close off positions when the price reaches the set price, called the stop-loss price. If the stop price is hit, the order becomes a market order and is executed at the best available price.
- Limit stop-loss orders:
Limit stop-loss orders or stop-limit orders, are very similar to regular stop-loss orders. The only difference is that when the stop-loss order gets triggered, it becomes a limit order and can only be executed within a certain range.
- Trailing stop-loss orders:
A trailing stop-loss order is an order or a stop-loss strategy that is adjusted based on the price movement. So, suppose a trader takes a long position in stock trading at ₹100 and sets a trailing stop-loss of ₹2. With the price at ₹100, the stop-loss will be triggered at ₹98. However, if the price jumps to ₹108, the new stop price is ₹106. Likewise, the trailing stop-loss order could even operate on a certain percentage.
When and Where Should a Stop-Loss Be Set?
Every trader should implement a stop-loss strategy for all of their trades, regardless of their trading approach. So, it doesn’t matter if you are an intraday trader, swing trader, or position trader—never trade without a stop-loss; implementing a stop-loss is one of the golden rules of trading. If you can’t successfully limit your risk, you are limiting your success as a trader. So, the answer to the question of when you should use a stop-loss is every time you take a position in the market. Our online financial calculators can help you with a variety of financial tasks, such as calculating loan payments, saving for retirement, and budgeting.
On the other hand, “where you should set your stop-loss” depends on factors like your trading style, strategy, the asset traded, and risk tolerance. Based on these factors, set the stop-loss at a reasonable level. For example, a stop-loss in intraday trading will be more conservative than one in a swing trade. That is because a swing trader can choose to take on higher risk than an intraday trader. Don’t miss out on the opportunity to use short-term trading strategies for your trades.
Stop-Loss Strategies
With the help of technical analysis and technical indicators, the trader may determine a particular methodology for setting a stop-loss. Let us look at some common strategies for placing a stop-loss in intraday trading.
- Percentage based:
One of the most common practices for a stop-loss strategy is determining the stop price by limiting the loss to a certain percentage of the trade value. For example, a trade may limit its stop-loss in intraday trading to 5% of the trade value. Depending on the trading approach, the size of the trade, and the traded asset, the percentage of loss will vary.
- Support and resistance based:
Traders may also determine their stop-loss levels by evaluating the key support and resistance levels. If the trader is taking a long position, they can place their stop-loss just below the support level. The rationale, in this scenario, is that the price will continue to tumble if it breaches its support level. On the other hand, if the trader is short-selling, they may place the stop-loss right above the resistance level. Their rationale here is that the price will continue to shoot upward if it crosses its resistance.
- Moving average:
The trader uses the moving average line as support in this stop-loss trading. So, they place their stop-loss right below the moving average. The trader may use any moving averages like the 10, 20, 50, or 100-day moving based on their trading strategy.
Mistakes to Avoid While Placing a Stop-Loss Order
Finally, let us discuss some of the most common mistakes most traders make while executing their stop-loss strategy.
- First and foremost, predetermine your stop-loss before making the trade. Don’t sit down to plan your stop-loss strategy after you’ve taken your positions.
- Set a reasonable stop-loss based on technical analysis, and don’t randomly decide on any numbers.
- Lastly, don’t take on too much risk, as it defeats the purpose of your stop-loss if you’re still losing a significant portion of the trade value.
Conclusion
To sum it up, day trading is a highly risky venture, so having a stop-loss strategy is crucial to deal with favorable contingencies. It will help you manage risk, limit your downsides, and preserve your capital. Remember that if you wish to succeed as a trader, you have to focus more on reducing your losses than aiming for larger profits. If the magnitude of your losses is high, they will offset your profits. So, always trade with a reasonable stop-loss order.