What Is A Stop-Loss Order? Why Should I Care?

By: pcorp2006
A stop-loss order is the trader's best friend. The reason for this is simple: the stop-loss order can help the savvy investor avoid losses, and protect gains. With something of this great of value, you'd be almost sure that everyone would already know about it and use it. This is not the case. Many neophyte investors seems to either not know or not care about protecting their downside.

How does a stop loss work?

A stop-loss order is generally a limit order that executes at a given price. If you have a stock you bought at $18, and it's not at $24, you've made a hefty profit and can use a stop loss to protect your profit. If you set your stop-loss order to $23, if the stock falls by a dollar, the trade will automatically execute, and you'll be sitting comfortably on the sidelines, in the green. The beauty of the stop-loss is that it's automatic. You don't need to fret whether to make the trade, and you don't have to be sitting next to your terminal waiting to hit the "SELL" button. Stop-loss orders can be setup as "Good Til Cancelled", so you can basically "set it and forget it".

Can a stop-loss order hurt you?

Many new investors are frightened to use a stop-loss order for fear the trade will execute on temporary news, and the trade will be closed. This is a real possibility, and for this reason you need to be careful when setting the amount that triggers the order. Many people use a 8% stop, but this might be too tight for many volatile issues. But a 15% margin should give you plenty of wiggle room. If a stock loses 15% of its' value in one trading session, you'll be very happy you're in cash soon enough.

Trailing stop-losses protect your gains.

If you are already in the green, you can use a trailing stop loss to protect your gains. A trailing stop-loss is set to automatically trail the share price by a certain amount. If it's 15% and the stock is at $100, the stop-loss will execute at $85. If the stock went to $200, the stop loss would be at $170. This way you always protect yourself against a loss automatically, as soon as the stock goes down in price.

The terminology for stop-loss orders changes from brokerage to brokerage, so you'll have to check your console for the exact order on setting one up. Generally it's a one-click process that is quite easy. There may be a small fee, but generally there is not. If you forego using stop-losses, you better at least be prepared to be an extremely active trader who monitors your investments constantly. Failure to do so for even a day can result in huge losses. Take a look at the massive selloff in companies like Taser or Google to see just how disastrously even a great trade can get if you don't protect the downside.
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