What is Stop Loss Order and Risk

Management 2023| Wealth Secret

March 23, 2023 by Wealth Secret

Introduction
Stop-loss orders and Risk Management are a way for investors to manage their risks. If the
price of a security falls below a certain point, the stop-loss order will automatically initiate
the sale of stocks or bonds, limiting any losses incurred. This type of order provides investors
with an efficient way to set boundaries on their losses and maintain a certain level of
protection for their investments.

There are two types of Stop Loss Orders

1. Fixed Stop Loss

A fixed stop loss is a trading tool employed by investors and traders alike that are used to
limit the loss in any trade they enter. This type of order triggers a stop loss when the price
reaches a predetermined point and it can be set to an exact value or to be time-bound.

Fixed stop loss orders can be helpful for investors who want to allow the position a set
amount of time to generate profit before moving on to the next trade. Nevertheless, when
employing these types of stops it is crucial to size your positions correctly so that they can
handle major adverse movements in share price.
2. Trailing Stop Loss

The Trailing Stop-Loss Order is an ideal order for investors seeking to maximize their capital
gains and hedge their losses. With this order, a trader sets a predetermined percentage level
based on the asset’s total value. If the market prices fall below this set percentage, the sell
order will be activated.

If the asset increases in value, the Trailing Stop-Loss Order automatically readjusts itself.
This order provides protection and allows traders to benefit from price hikes without the need
to manually monitor the market.

Difference between Stop Loss Order and Market Order

Stop-Loss Orders and Market Orders differ greatly. A Stop-Loss Order sets a limit below
which the stock can’t go and will execute the sale as soon as the limit is reached. A Market
Order, on the other hand, is an order to the broker to execute a trade based on the prevailing
market price and is useful in providing more liquidity in the stock market.

Whereas a Stop-Loss Order limits risk, a Market Order helps to eliminate the gap between
bid and ask prices. Thus, a Market Order is a simple yet powerful way to increase trade
volume in a stock market.

Limit Orders
Limit orders are tools used to control the price at which transactions are made. When the
limit is set, the order will be executed only if the security is priced at that level or higher for a
buy order, and lower for a sell order. Limit orders provide the benefit of helping investors
capture potential profits when prices rise, as well as minimizing potential losses if prices fall.

Stop-loss orders, on the other hand, are triggered at the specific price the investor chooses
and works in the opposite way of limit orders – if the price drops, the stop-loss order will
buy, and if it rises, it will sell. Therefore, stop-loss orders help traders protect against
unexpected price moves in the market.

Advantages of using Stop Loss Orders

1. Avoiding Large Financial Risks

Utilizing the concept of stop loss allows you to minimize the potential risk you could be
exposed to, particularly in the volatile stock market. Instead of leaving yourself vulnerable to
suffering a major financial hit, placing a stop loss allows you to safeguard your capital and
have more peace of mind when making trades.

2. Management of Risks

When it comes to stock trading, there is a careful balance between risk and reward that
should be adhered to. Taking calculated risks can pay off handsomely, but it is important to
never overextend yourself. Find your comfortable risk level, and be consistent with it to make
sure the rewards you earn will be commensurate with the risk taken. Taking too much of a
gamble could spell disaster. Risk should never outshine the potential rewards.

3. Commitment to fixed goals and decisions

Disciplined trading is key when investing, and setting a stop loss helps keep emotions in
check and ensures that your financial strategy is respected. Establishing stop-loss levels can
help keep an investor focused on their goals and keep them disciplined in their trading
decisions.

Disadvantages of using Stop Loss Orders

1. Not Investing Wisely

Using stop-loss strategies when trading stocks could result in investors having to prematurely
close a trade. This could mean potentially missing out on higher returns due to unwillingness
to accept a higher level of risk. Investing wisely and with an understanding of market
behavior can help minimize the potential losses from such tactics. Any trader needs to have a
plan in place to determine when a position should be exited so that maximum profits can be
gained, as well as limiting potential losses.

2. Not setting proper Limit

Setting a stop-loss limit is a key decision investors have to make. The difficulty lies in
deciding the right price to set the limit, so seeking advice from financial advisors can be
helpful – but it won’t come free.

3. Expensive charge

Stop-loss orders can often be costly for investors since their stockbroker may impose
additional charges for executing this type of order. As a result, it can sometimes be more
expensive to use stop-loss orders than other investing methods, so investors should carefully
weigh the costs and benefits before proceeding.

Why is Stop Loss Order Important?

Stop-loss order plays a crucial role in assisting investors to restrict losses from any
fluctuations in the market without close market monitoring. Risk-averse investors who want
to benefit from stock market investments with the least risk, greatly benefit from the
protection provided by stop-loss orders.

Rather than leaving the stock position to reach its peak and incur substantial losses if prices
fluctuate, a stop-loss order allows individuals to exit the position without being affected by
market uncertainties. This ensures investors don’t suffer from excessive losses despite the
lack of certainty of when the highest or lowest value is reached.

Conclusion
Stop-loss orders can provide investors with a certain level of protection from volatile share
prices, but it is not immune from any freefall in prices due to a lack of sufficient buyers. As
such, losses incurred due to a stop-loss order may exceed the originally predicted amount as
not only the principal investment may not be recovered but capital gains can be lost.
Additionally, any drastic downturn in prices could render stop-loss orders impossible to
execute, resulting in investors potentially bearing the brunt of more losses. Despite these
issues, it can still be beneficial to investors with low-risk tolerances, and investors should
evaluate the pros and cons of stop-loss orders when determining their investment strategies.

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FAQs
What is the difference between Stop Loss and Take Profit orders?

Stop Loss orders are placed to limit losses in case the market moves against the trader while
Take Profit orders are placed to lock in profits if the market moves in the trader’s favor.

What are some common Risk Management strategies?

Common Risk Management strategies include setting Stop Loss orders, diversifying
investments, and using position sizing to control risk exposure.

What is Stop Loss and Risk Management?

Stop Loss and Risk Management are strategies used in investing to limit losses and protect
profits. It involves setting predetermined points at which a position will be closed to prevent
additional losses if the market moves against a trader.

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