One important attribute of any trading system is the ability to keep losses small. This is what an investor can achieve with the use of Stop Loss. Setting a stop loss is a trading strategy which an investor can place with the broker to protect his investments by minimize the risk in trading. In Simple words, Stop Loss is an order placed by the investor in advance to automatically liquidate/sell his share/securities if it reaches at a certain price level. Investors can decide and fix their Stop Loss limit as per his risk taking capacity. Placing a stop-loss order for 10% below the price at which you bought the stock will limit your loss to 10% if the market does not move in the preferred direction. For instance, let’s say you purchased stock at Rs 200 per share. Right after buying the stock you enter a stop-loss order for Rs 180. This means that if the price of the stock falls below Rs 180, your shares will then be sold at the current market price. This is a strategy that investors use to determine their loss limit in advance, preventing more losses to occur.
A trailing stop is a type of stop-loss order that moves as market price fluctuates. In simple words, If the market price of the securities increases, the stop loss price increases proportionately, but if the stock price falls, the stop loss price doesn’t change. This method allows an investor to set a limit on the maximum possible loss without setting a limit on the maximum possible gain.
For example, Lets say you purchased a stock at Rs 500, a stock trailing stop price placed at Rs 450. If the price then moved up to Rs 550, the trailing stop would move to Rs 500. If the price continued up to Rs 600, the trailing stop would move to Rs 550. If the price then moved back down to Rs 575, the trailing stop would stay at Rs 550. If the price continued down and reached 550, the trailing stop would exit the trade at Rs 500.
Best Of Fixed Stop & Trailing Stop Order
One of the best ways to maximize the profits of a trailing stop and a traditional stop loss is to combine both of them. Yes, you can use both, but it is important to note that initially the trailing stop should be more than your regular stop loss.
For example, set stop loss at 5% and the trailing stop at 5.5%. As the price of the stock increases, the trailing stop will surpass the fixed stop loss, making it obsolete. Any further increase in price mean further minimizing potential losses. But make sure to cancel your original stop loss when the trailing stop surpasses it. The added protection here is that the trailing stop will only move up.