Stop loss order is one of the methods to minimize the loss in a volatile stock market. A good stop-loss strategy can lead to high returns to the trader as it is a simple tool to lock in profit at a fixed decided price by the trader.
The trader places an order with the broker to sell the specific stock at a certain price. For example, when a trader invests in any stock which is currently at Rs100. The stop loss order can be fixed by the trader at Re 96 which means the trader can take only a loss of Rs 4 per unit. When the prices fall it will help in reducing loss.
There are various advantages in applying for a stop-loss order. The major advantage is the trader can analyze and make the best judgment call before the market fluctuates. Another advantage of stop loss order is that it does not cost any extra charges for implementation. It is a very simple concept that allows the broker to sell the stocks when the market is showing downward movement with no extra commission. However, placing an accurate stop loss in a volatile market is a hard task. The traders should keep some factors in mind before selecting a strategy.
There are different ideas in concern with stop loss order strategy which need to be factored in before selecting an optimal stop loss strategy which is discussed below:
Placement of Stop Loss Order
To attain a good stop loss strategy the placing of stop loss plays a huge role. As if the stock moved in the opposite direction the trader can lose an opportunity of making high returns. To place stop order it is important to discuss support and resistance in day trading. Support in trading means a price level when a falling stock can bounce back as the demand of particular stock increases with a dropping price. Meanwhile, the resistance works exactly the opposite of support as prices increase with the sale of stock.
This creates a pause for some time in the trading cycle. The trader has to understand when the stop-loss order can give the best result. Therefore, whenever the stock is bought or sold, there should always be a little and time should be given to analyze the market flows and changes.
This timing of support and resistance needs to be determined that the price is moving in the right direction or wrong direction. Hence the market position can be adjusted at a small loss.
Method of Calculation
The success of stop-loss strategy also depends on the method used for the calculation of stop loss strategy. There are majorly two methods of calculation which are percentage and moving average method.
In the percentage method, the fixed percentage is assigned. Depending on the strategy the method varies as in percentage method For example, the stocks which fluctuate at the rate of 20% assigning a stop loss order at 10% is not the best course of action. There is no hard and fast rule for this calculation, so the trader has to understand its volume of units and risk appetite before choosing any method.
The moving average method is calculated by applying moving average to stock market trends. It is selected in the fast-moving market as the prices of stocks change rapidly. The traders should also use a long-term moving average for better results. The stop loss is generally placed below the average to feel safe in following the stop-loss strategy.
In the end, To achieve a successful stop-loss strategy, the investor has to show some faith and analysis in the decision as the market is volatile and it can only help in leading in the right track but choice and decision is always in the trader’s hand and it is important that it is not clouded with human emotions.