Stop-Loss Order

What is Stop-Loss Order (Stop Order)?

Stop-loss order is an advanced version of computer activated trade tool which is mostly allowed by brokers so that the trade is executed for a particular stock if only the predetermined price-levels are obtained while trading and such type of orders are designed only for minimizing the investors’ loss burden. This order ensures a high probability of the investor to achieve a predetermined entry price or exit price. This is used by investors as it helps them to limit the losses and lock in the profits. Once this price crosses the determined entry point or exit point the stop order converts into a market order.

Stop-Loss Order

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Method for Calculating Stop-Loss Order

#1 – Percentage Method

Let us consider you are comfortable with losing 10% of the value of your Apple’s share and consider that it is now trading at $100. Then you would set a stop-loss order at (100*10%) = 10=100 – 10 = 90

#2 – Support Method

The support method is based on technical indicators and also based on the current trend as the investor identifies a support level and places a stop-loss order at that price. For example, the investor considers the support method of the Apple stock to be $80. Then stop-loss order would also be set at this level.

#3 – Moving Average Method

The moving average method calculates the moving average typically for a longer period of time and then, on the basis of that, places a stop-loss order below that level. The moving average of Apple is at $80; then, in the moving average method, the stop order can be placed at $79.

Examples

Example #1

Let’s assume you own a hundred shares of Apple, and you have bought the share at $100 per share. The expectation is that the share might reach $120 in the next month, but you do not want to take the risk of it going the other way.

You ask your broker to put a stop order at $90. In this case, if the stock goes up, all the profits will be realized by you. But if the stock goes down and touches $90, the order will automatically be market order and will be placed.

It is not necessary that the order will be placed at $90; it can also happen that it will be placed either $89 or at $91 based on the market conditions.

Stop Order Example

Example #2 – Portfolio

Your portfolio size is $1,00,000, and the risk you are willing to take is 1%. The total risk for your portfolio, which you are willing to take, is 1%, which sums the total amount to $1000.The position size is $12,500. This is the total amount of risk you are willing to take.

The stop-loss order is placed at 8%, and the current share price is $50. Considering the stop-loss order at 8%, the share price and the risk you are willing to take are at $46 per share. That is the total amount of loss per share at $4.

Instead of stop-loss, if the protection was on the gain, then at 20%, the total profit would have been $60. Similarly, at 30%, it would have been $65, and at 40%, it would have been $70.

This is how stop-loss or gains are calculated based on the total portfolio amount and the risk you are willing to take.

Advantages

One important point to discuss before getting on to the advantages of a stop order is that the advantage to one trader could be a disadvantage to others.

Disadvantages

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