- Stop-loss is an order issued by an investor to their broker to sell a security if its price falls below a specific price.
- Stop-loss order limits losses and secures the gains.
- A stop-loss order makes investors free of emotional and pressurized decisions.
What is Stop Loss?
Stop-loss is an order issued by an investor to their broker to sell a security if its price falls below a specific price. The stop-loss order is valid for a day and lapses if not triggered during that trading day. Order gets changed to a market order when the stock price gets lower than the stop price.
Example of a Stop-Loss order
For a company’s common shares trading at Rs 400 a share, a stop loss may be issued in case the price is expected to fall, with the stop-loss price being Rs 380. Should the share price continue falling and go below Rs 380, the investor’s shares are sold automatically.
How does Stop-Loss order work?
A stop-loss order is a trade order given to the brokerages by a trader. The trade is executed after the stock price falls to a particular stop price. Such types of orders work towards limiting the loss of investors in a specific position.
Let’s say if an investor has a long position in 20 shares of Axis bank that he/she bought for Rs 310 per share. Consider that now the shares are trading at Rs 330 each, and the investor wants to hold the stock in the hope of further price appreciation since the investor does not want to lose the unrealized gains, so he/she decides to sell his/her position if the price falls to Rs 320.50. Thus, the investor can get into a stop-loss order, which orders the brokerage to sell the 20 shares of Tesla Inc. in case the price falls to Rs 320.5.
Advantages of Stop-Loss order
The benefits of a stop-loss order include:
- It enables locking in a profit
- The investor can “set and forget it”
- It limits the expected losses
- It does not cost anything
- It makes investor free of pressurized decisions
Disadvantages of a Stop-Loss order
- It limits gains
- It is not well suited for volatile stocks
- The realized sale price can be less than the stop price
- It can be triggered because of a temporary fall in price