Stop Loss Order – Meaning, Example, Advantages and Disadvantages

Stop Loss Order Meaning

All of you must be using mobile and the moment mobile battery goes below 20 percent it will trigger a beep and message comes in mobile that your battery is low and after seeing that message you quickly charge the mobile. Stop loss order works pretty much, in the same way, the moment the price of the stock falls below a set price it triggers a sell order and the stock is sold at market price. Stop order in simple words refers to that order using which a trader can limit his or her loss while trading stocks in the stock market.

Stop Loss Order Example

An example of stop order is suppose you hold 100 stocks Amazon Company and your purchase price is $500 and it is trading at $550. As a trader or investor, your prediction or analysis is that it will move to $600 but you also want to protect profits than you will place a stop order at $525 so that you earn a profit of $25 no matter what happens to the stock price of Amazon. Hence the moment stock price of Amazon falls below $525 your stop loss order will be triggered and it will become market order implying that it will be sold at market price which may be $520 or $530 at the time of execution of stop order.

Advantages of Stop Loss Order

Helps in Restricting Loss

The biggest advantage of stop-loss order is that it helps in restricting loss for a trader because stock market tends to be very volatile and if the movement in price of stock is against the trader than stop order can be of great use as it helps the trader in cutting the positions and saving of capital because if there are no stop loss orders than risk of trader losing whole capital in one trader rises which cannot be regarded as good way to trade the stocks in stock market.

Helps in Protecting Profits

Another benefit of stop-loss order is that it helps in protecting profits of both investors as well as trader because as in the above example if an individual would not have placed stop order at $525 and Amazon stock had fallen below back to $500 or even lower than whole profit of an individual would have wiped out. Hence in simple words apart from restricting losses it also helps in protecting profits of both traders as well as investors.

No Need for Daily Monitoring of Prices

Once an individual has placed stop order with broker he or she does not need to worry about daily movement in stock price and hence one can say that by putting stop order one is saved from the daily stress of keeping a close eye on day to day movement of stock price.

Disadvantages of Stop Loss Order

Possibility of Loss due to wide Fluctuations

The biggest risk of putting stop order is that in fluctuating markets sometimes the price hits the stop loss price and then rise to make new high which in turn results in trader or investor losing out the opportunity to make profits. Hence in the above example if the price of Amazon go below $525 for few minutes and then touches the price of $575 than individual will lose out $50 due to putting a stop loss.

Stop Order Becomes Market Order

Another disadvantage of stop order is that once stop loss order is triggered it becomes a market order and when the market is falling quickly than chances are that price at which stock gets sold may be significantly lower than stop loss price. Hence in the above example if the price of Amazon goes to $515 quickly after hitting $525 then the whole idea of putting stop order is useless as instead of protecting profit at $25 an individual has made a profit of only $15.

Complex to Understand

It is not easy to understand for a layman and if a person without knowing fully its implications put such order than it will do more harm than good for a person. In simple words, it should be used by those individuals only who are having a sound financial knowledge and are fully aware about how stop-loss order works.

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