What is Stop Loss in Stock Market?

A stop loss is probably one of the best tools in a trader’s life that helps them curtail losses in an unfavourable market. Trading in the stock market involves leverage and margin. It has the potential to boost your returns, however, it is equally possible that it can magnify your losses as well. To prevent such a situation, brokers offer a stop loss or SL on the trading platform. Traders use this tool frequently and rely on it during volatile markets. A stop loss can be set by for a desired price to mitigate the risk of market moving in an unfavourable direction.

What is a Stop Loss Order?

A stop-loss order enables a user to square-off their position at a defined price, automatically, in a loss-making situation. A stop-loss order is used while trading in intraday , equity and derivatives. Stop loss order can be used on both sides of the position you take. Depending on whether you are on a long or a short position, you can set a buy or sell stop-loss order to restrict your losses.

There are two types of stop loss order:

  • Limit Order : A stop loss limit order is an order where you choose a specific price to exit from the trade in the event of the trade moving against you. Once this price is hit, the order will be automatically squared off, with restricted losses.
  • To understand this better, let us take an example. A trader takes a short position on an X stock at Rs. 100 and aiming a target price of Rs.90. However, the market is volatile, and he expects the stock may rise to Rs. 110 as well. The price can swing either way. Keeping this in mind, he puts a stop-loss limit order at Rs. 103. Now, if the prices go up, instead of going down as the trader had speculated, then the stop loss limit order will be executed when it hits Rs. 103. If the market keeps moving up after that, the trader will be able to restrict its losses significantly.

  • Market-Order : A stop loss market order means that the order will be executed at the next available price after the order is confirmed.
  • Let us take the same example to understand a stop loss market order. The trader took the short position at Rs. 100 and set a Stop Loss Market order at Rs.104. When the current market price of share reaches Rs.104, the position will be squared-off at the next available price.

  • Stop Loss Trigger Price : A trigger price is the price at which a buy or sell order gets activated to be executed. It simply means that if the trigger price you set is hit, the order is sent to the exchange. It is usually set very close to the limit price.
  • We will again take the same example to understand this. If our stop loss limit order is set at Rs. 103, a trigger price will be kept around Rs. 102.50. So, when the price touches Rs. 102.50 a buy order request will be sent to the exchange and the order will be executed at Rs. 103 or below.

Understanding Stop Loss Orders

With all said and done, the simplest way to understand a stop loss order is that it is simply an order opposite to your trade position. Let us understand with the help of a few points.

  • If you have bought a stock and expect the prices to rise, but it starts fallings instead. You can anticipate this in advance and set a stop loss order at a price where your losses will be in control.
  • Another feature about a stop loss order is that you exit the trade with a loss. However, this loss is a much-restricted loss and could have been worse if there wasn’t a stop loss order placed.
  • Although using a stop loss order is always recommended while trading, but it is important to identify the right price to set the order. To identify the right price, you should look at the charts and identify the support and resistance points to pick your SL order price.

How to Use Stop Losses Order?

A stop loss order has several advantages and to use it right, is one of the most important aspects of being a successful trader.

  • Use it on both sides: A stop loss order can be used on both sides of a trade, whether you take a long or a short position, you can place an opposite order, as a stop loss order, to mitigate the risks.
  • Choosing the right price: While setting up a stop loss order, the key aspect is choosing the right price. One should check the support and resistance levels on the chart to set the right price. The stop loss order should not be too close to the entry price. If you keep it too close, then it is possible that it hits your SL order and then starts moving in your favoured direction.
  • Risk-Reward Understanding:As a trader, you need to keep your emotions in check and evaluate the risk-reward ratio. You should come up with a strategy for your trades and irrespective how the market moves, you should stick to the strategy. This discipline will help you as a trader to restrict your losses and grow your capital.
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