What is a Stop-Loss Order? Types, Benefits & Limitations Explained!

What is a Stop-Loss Order? Types, Benefits & Limitations Explained!

What is a Stop Loss Order: Hello, future and fellow investors and welcome to FinGrad. We’ve all heard stories of investors making once-in-a-lifetime gains on their holdings in the stock market.

But behind the success of a handful of successful investors are millions more who have lost their savings and investments in the market. How can you, a new investor, avoid losing all your funds and mitigate your losses? Read on to find out. 

Today we’re going to talk about what is a Stop Loss order Limit. If you want to know exactly how to place a stop-loss order on a trading portal, watch our video below – What is Stop Loss?

What is a Stop Loss Order?

When you buy a certain share(s), you have the option of setting up an order to sell your holding once it falls to a certain price. This option or order is called the Stop-Loss order.

For Example –  Assume you bought 100 shares of Company ZNA  at Rupees 50 each. You place a stop-loss order of Rs. 45 per share. When the market price falls to Rs. 45 or lower, the order is completed. Your loss is stopped at Rs.5 per share on your initial investment. 

The purpose of stop-loss is to reduce risk without actively monitoring the share price on a daily basis. 

Types of Stop Loss Orders

There are two types of orders under Stop-Loss

1. Market Stop Loss

This is a market order set up to sell your holdings as soon as it breaches the mentioned trigger price. Once the stock reaches this price, it is sold. 

2. Limit Stop Loss

A Limit stop loss is a limit order to sell your holdings once the stock price reaches the trigger price. The limit price is set so that the stock does not get sold once it falls below the limit and further increases investors’ losses.

Benefits of Using a Stop Loss

1. Minimize Loss and Risk

The prime focus of making a stop-loss order is to mitigate the losses of a share, should its price fall below a certain level. This protects investors from losing out on more funds than they are comfortable with. Any investor anticipates growth in his portfolio after making an investment. Should the shares go in the opposite direction and fall, he can make an order to prevent larger losses. 

2. Removal of Emotional Bias while investing

When the order to sell at a certain price is booked, investors feel slightly secure that their net holdings are not completely lost. This allows them to focus on other potential investments as well. 

3. Can be used to make profits as well as mitigate losses

Similar to how stop-loss sells your shares after it reaches a certain price to mitigate losses, the same can be said for making profits as well. Investors can set a higher limit to sell, should their shares reach that price. 

Limitations of Stop-Loss

1. Orders get triggered quickly due to intra-day market fluctuations

This means the prices could breach the limit and potentially climb back higher than the opening price of the day. This makes investors lose out on profits that could have been made had they held their position longer. If you bought a share with an average fluctuation of 12% and your stop-loss order is marked at 6% below share value, then losing money is highly likely.

2. Possibility of the order being executed below trigger price in the market

A Stop-loss order might get triggered instantly in modern-day trading. However, there are chances that the shares will be sold at a price lower than the limit set by investors. This could be avoided using stop-limit order, but not stop-loss.

3. Investors’ Decision

The order is placed solely based on the investors’ choice. There are no rules and guidelines for placing stop-loss and it varies across investors. Mostly, individual research has to be done before coming to a decision. 

In Closing

A Stop-loss is a feature that can be used wisely to reduce risk and losses before the share falls further in value. The orders can also be placed to sell positions when the share price rises in value as well.

It works in both directions and saves you time from observing the market continuously. That’s all for the article on What is a Stop Loss Order, we hope you enjoyed reading it.

For more tips and ideas on investing, check out the Courses section on FinGrad. As always, Happy Investing!

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