Nobody wants to lose money when they are trading. That is why it is critical to establish a floor for your position in security. This is where stop loss orders come into play.
However, many investors struggle to determine where to set their levels. Setting them up too far apart can result in significant losses if the market moves in the opposite direction. Set your stop-losses too close together, and you may exit a position too quickly.
So, how do you know where to place your stop-loss order?
Stop-loss orders are similar to standing orders to your broker in that they are placed when a stock reaches your stop-loss price. It acts as a warning system to keep you trading within your limits.
This is one of the most effective risk management tools traders use to limit large losses. While you may know how to set a stop loss, you may be interested in knowing at what level to place one. Here are six ways to set your stop-loss level to help you decide.
So, In today’s blog, let us learn how to set a stop loss when trading in the stock market:
- What is Stop-Loss Order?
- Importance of Placing Stop Loss
- Methods of Setting Stop Loss
- Mistakes to avoid
- Watch this video on Stop-Loss by Mr. Vivek Bajaj
What is Stop-Loss Order?
Planning your trades is a big part of limiting your trading losses. This includes your entry and exit points. You must determine how much you will lose if the trade does not go your way ahead of time.
Newer traders frequently prefer to automate this process by using stop-loss orders, also known as stop orders.
A stop-loss order exits your position if your stock reaches the price you specify. The stop price is the point at which you want to cut your losses.
If the stock reaches that level, your market order will be filled automatically. Stop-loss orders can be beneficial. They can keep emotions from getting in the way of cutting losses. It’s all too easy to believe that the trade will improve. When it doesn’t, you’re left with a major loss.
Importance of Placing Stop Loss
It is critical to protect yourself from losses when trading. Losses aren’t fun, are they? Unfortunately, they do occur. It is simply not possible to have every trade working. It happens even to large hedge funds.
So don’t be too hard on yourself; it’s all part of the trading process. You may believe that this is negative thinking.
However, any trade has a good chance of not going your way. It is critical that you mentally prepare to lose. It will happen again and again.
New traders frequently overlook the importance of capital protection. However, if you don’t think about it — especially if you trade with a small account — you can quickly blow up your account.
As a result, whenever you enter a trade, you must consider where to place your stop loss.
It’s critical if you’re not yet good at cutting losses. The ultimate goal is to protect your capital and avoid blowing up your account. You’re out of the game once you do that. And starting over isn’t always easy.
Methods of Setting Stop Loss
1. Fixed Amount
That is the most you can risk losing on a trade. Assume you buy a stock at Rs. 100 and cannot bear a loss of more than Rs. 10 per share. So, your stop-loss will be set at Rs. 90 over.
2. Fixed Percentage
That’s the maximum % you can afford to lose on a trade. Let’s say you buy a stock at Rs. 100 and can’t bear a loss of more than 5%. You’ll set your stop-loss at Rs. 95
3. Swing Highs and Lows
One can set stop loss at the swing high and swing lows of the week, month, or even more if you are a long-term trader, as shown below-
4. Support and Resistance
Support and Resistance levels are often used by traders to determine the stop-loss levels as shown below-
If a stock doesn’t perform as you expected it to within a certain time frame, let’s say you sell it. The period could be one week for a positional trader or one day for a day trader.
A process for trailing a stop loss is already in place. Here you move your stop loss as per the movement of stock in your favor; for, e.g., if the stock moves up 50 pts., you raise the stop loss by 50 points.
You can also do our course on Masterclass on Short-term Momentum Trading
Mistakes to avoid
Here are a few mistakes that the trader needs to avoid while placing a stop loss:
1. Not Determining your Stop Placement in Advance:
A trader should know where his stop is going to be before he takes the position. The benefit of ascertaining your stop loss before you open trade is that it removes any emotions from the decision.
2. Placing your Stop Based on Arbitrary Numbers:
One shouldn’t place their stop loss based on arbitrary numbers. They should determine their stop loss based on technical parameters as discussed above.
Watch this video on Stop-Loss by Mr. Vivek Bajaj
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