One of the most important rules in trade is to plan trades and trades as planned. This plan can take many forms. It can rely on technical analysis, fundamental analysis, numerology, sunspots – everything. The fact is that you really need a plan before your trade becomes active. Trading plans may have different components, but stop-loss is one of the most important components. Your plan should include both positive and negative rules or criteria for exiting the transaction. Of course, these rules can be much more complicated than the price tag you sell – which is the goal of stop loss and profit – but most amateur traders don’t develop (and can’t) develop more complex rules. Therefore, it is important to understand stop-loss – what it is, their importance and be able to use it in trading.
Order placed with a broker to sell collateral when it reaches a certain price. A stop-loss order is designed to limit an investor’s losses on a position in a hei security. Although most investors associate stop-loss only with a long position, it can also be used for a short position, in which case the hedge will be purchased if it is quoted above the Price. Stop-loss removes emotions from trading decisions and can be especially convenient when a person is on vacation or can’t track their position. However, results are not guaranteed, especially in situations where stock trading stops or the price falls (or rises) with a gap.
When using stop-loss on a long position, a sell-off market order is triggered when shares trade below a certain price and will be sold at the next affordable price. This type of order works well if stocks or the market are falling in an orderly manner, but not if the decline is messy or sharp.
For example, if you own shares of ABC Co., which currently trades at $50 and you want to insure against a big drop, you can enter a stop-loss to sell your ABC assets for $48. This type of stop-loss is also called a stop-for-sale order. If abc trades below $48, your stop-loss is triggered, which is converted into a market order to sell ABC at the next affordable price. If the next price is $47.90, your ABC shares will be sold for $47.90.
But what if ABC closes at $48.50 in one day and then reports a weak quarterly profit after the market closes? If the shares fall the next day and open at $44.90, the stop-loss will automatically stop running and your shares will be sold at the next affordable price of, say, $45. In this case, your stop-loss didn’t work as you expected, because the ABC loss is 10%, not the 4% you expected when you set a stop-loss.
This is the main drawback of stop orders and the reason why experienced traders use stop-limit orders instead of stop-market orders. Stop-limit orders are designed to sell shares at a certain limit price, not at a market price, as soon as a certain price level is broken. Although stop-limit orders also won’t work if stocks are stopped or have a price gap, the risk of selling a long position at a much lower price than a certain stop price is lower than a stop-market order.
It should be noted that stop-loss is an order that can be used to protect unrealised profits, although in this case it would be more accurate to call them stop orders rather than stop orders.
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