Often in trading, we hear the term Stop-loss, but what exactly it means is the purpose of this blog. In simple ad short words for your understanding, Stop- loss is an advanced way to sell an asset when it reaches a particular price point.
Now the question arises why and how to use it? When is the correct time of placing a stop-loss? What are the advantages and disadvantages that are involved in the process?
To answer all the above questions let's simplify the fact that stop-loss irks the profits and limits the loss. By placing a stop-loss order, the investor instructs the broker/agent to sell a security when it reaches a pre-set price limit to avoid any hustle or any inconvenience while their trading experience.
STOP- LOSS ORDER- “AN EXIT PLAN”
To limit your risk on a trade, you need an exit plan. And when a trade goes against you, a stop-loss order is a crucial part of that plan. A stop loss is an offsetting order that exits your trade once a certain price level is reached.
Here's an example. If you trade gold at $200 and place a stop-loss order at $199.50, your stop-loss order will execute when the price reaches $199.50, thereby preventing further loss. If the price never dips down to $199.50, then your stop-loss order won't execute.
IMPORTANCE OF PLACING A STOP-LOSS ORDER
Most investors can benefit from implementing a stop-loss order.
A stop-loss is designed to limit an investor's loss on a security position that makes an unfavorable move.
One key advantage of using a stop-loss order is you don't need to monitor your holdings daily.
A disadvantage is that a short-term price fluctuation could activate the stop and trigger an unnecessary sale.
HOW TO PLACE A STOP LOSS AT THE RIGHT TIME?
A good stop-loss strategy involves placing your stop-loss at a location where will let you know you were wrong about the direction of the market if hit. You probably won't have the luck of perfect timing all your trades. As much as you'd like it to, the price won't always shoot up right after you invest. Therefore, when you buy, give the trade a bit of room to move before it starts to go up. Instead of trying to prevent any loss, a stop-loss is intended to exit a position if the price drops so much that you had the wrong expectation about the market's direction.
When you invest in gold, a general guideline places your stop-loss price below a recent price bar low (a "swing low"). Which price bar you select to place your stop-loss below will vary by strategy, but this makes a logical stop-loss location because the price bounced off that low point. If the price moves below that low, you may be wrong about the market direction, and you'll know it's time to exit the trade.
At the end of the day, if you are going to be a successful investor, you have to be confident in your strategy. This means carrying through with your plan. The advantage of stop-loss orders is that they can help you stay on track and prevent your judgment from getting clouded with emotion.