Trade Smart: A Beginner's Guide To Stop-Loss Orders

February 23, 2021 02:15 PM
Stop-losses

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With so many variables at play, buying stocks can feel like walking a tight-rope. Striking that fine balance on your positions can demand extraordinary attention to detail, watching prices change and market move, and knowing when to sell. It’s impossible to watch the markets 24/7, so sometimes an insurance policy can save you a costly loss— that’s where a stop-loss order can save your investment.

 

What’s A Stop-Loss?

Almost every position can benefit from implementing a stop-loss order, so no matter what you’re trading, stop-losses are worth exploring. In short, a stop-loss order is designed to limit your losses should something go awry— it’s a failsafe mechanism that protects your investment and keeps you in the game. If your position makes an unfavorable move, the stop-loss will kick in automatically. Seems like a no-brainer.

 

Pros And Cons Of Stop-Loss Orders

Investing is a time-consuming process, but with attention to detail, everyone can execute good trades. With complex positions, it can become impossible to keep an eye on all of your trades at once. This is where the big advantage of a stop-loss comes in. “You don’t need to monitor a stop-loss order daily because it’s tied to a set of circumstances that, if found, will trigger the action,” says Angeline Chisholm, a tech writer at Write My X and 1Day1Write. “Your initial investment can be protected through a stop-loss order.”

However, because this process is automated, it’s possible that short-term market fluctuations that wouldn’t normally worry you could trigger a sale that you don’t want to make. The stop-loss, designed to prevent you losing money, could become costly.

There are a number of ways you can implement stop-loss orders depending on your position. Let’s take a look at how to maximize your investments.

 

Equity Stop

An equity stop is when a position will automatically be closed should the equity dip below a prearranged value. Conservative strategies will cap losses at around 2%, but 5% is a more common risk level. Thus with an investment of $100, the stop loss would be initiated if the account fell below $95.

An equity stop is an inflexible position and in volatile markets it could limit your return. For new investors, however, it’s the most straightforward way to place an insurance policy on your investment.

 

Volatility Stop

If you want your investment to weather mere market fluctuations without closing out your position, then a more flexible stop-loss measure might be the way to go. A volatility stop will rely on volatility indicators, such as VIX, rather than measuring equity. Should a market become too volatile, the position will be closed, but losses are deemed acceptable in accordance with long term strategy.

“In certain market conditions, a volatility stop will allow you to see your position make great gains,” says Henry Ivory, a finance blogger at PhD Kingdom and Britstudent. “It’s riskier than an equity stop, however, as simple pricing mechanisms will never trigger a sell.”

 

Event Stop

Most stop-loss orders utilize price action and market analysis tools to determine a sell point for a position, but for traders looking to secure their positions, there’s another way that’s worth discussing: event stops. An event stop bases a trade trigger point not on market action, but based on external events which run contradictory to the trader’s expectations.

This is a subtle position that allows multiple market variables to be weathered. Only in strict conditions— often unpredictable global changers that undermine your investment logic— will initiate closing a position.

 

Conclusion

There are multiple stop-loss orders that can be implemented on a position to act as a sort of security policy for traders. In addition to those enumerated above, there are also chart stops and volume stops, which utilize market events to trigger a trade. These stop-loss orders can save your bacon when the market moves. Every investor should be considering a stop-loss order of some type.

For beginner investors, the equity stop is the simplest and safest way to protect your investment. However, for more complex positions, you might not want a stop-loss to undermine you with triggers upon small market fluctuations. If you consider your options carefully, you can maximize profit whilst minimizing your risk.

About the Author

Regina Wheeler is an elearning consultant at Write My Research Paper and Next Coursework. She has been working in the financial services sector since 2011 and is based in New York. You can find her further writing at Coursework Help.