Before start reading the article please known one important thing – “Exit quickly from the losing trade is one of the best strategies to make money in trading.” So to exit from the losing trade you should know what is stop loss and how to use stop loss in trading.
Stop loss is one of the methods used by the traders to reduce loss or to book profit. It is an automatic order which you need to set when you buy the stock.
Let’s say you buy ABC stock at 300 price level. Within a few days the stock price fell to 250. What will happen? You may lose a huge amount of money. Here stop loss comes into play to save your capital. Do you How? When you buy the ABC stock, immediately you should set your stop loss order. Let’s say you set a stop loss order at 290 price level. When the stock price falls down to that level, the stop loss gets triggered and helps you to exit with minimal loss.
Table of Contents
Types of Stop Loss
There are two types of stop loss, They are:
- Fixed Stop Loss
- Trailing Stop Loss
1. Fixed Stop-Loss
As already said, fixed stop loss is used to protect the capital from huge loss. You could set fixed stop loss below swing low or use ATR level or moving average indicator.
2. Trailing Stop-Loss
Next one is trailing stop loss, it is used to safeguard the profits you earn from holding stocks. For example let’s say you bought ABC stock at 300 level and the stock price moves to 320 level. Now you can adjust stop loss to 310 level and protect the 10 points profit. You could set trailing stop loss based on the percentage or use any of the indicators.
How to set trailing stop loss in zerodha
Advantages:
Reducing Losses
As already said, the main purpose of stop loss is to reduce loss and save your capital. Thus, placing a stop loss order is very important to stand in trading for the long term.
Maintain Risk Reward
Risk Reward is one of the important pillars in trading. If you omit risk reward, then it is very difficult to make consistent profit from trading. Here stop loss helps us to maintain a risk reward ratio. For example you could put 5% percent stop loss and 10% target. It is a 1:2 risk reward.
Helps to maintain Discipline
Discipline plays a vital role in stock trading. If you are not disciplined enough to follow rules and strategy, then making consistent profit is hard. In trading you need to manage your emotions because it affects your discipline. So stop loss will help you to follow your rules and maintain discipline.
Also Read: Mastering the 3 Triangle Pattern: Tips and Tricks for Successful Trading
Disadvantages
Although stop loss is very important and mandatory for every trade, it has some disadvantages. Let’s see them,
Short term fluctuations
First disadvantage is Short term fluctuations. There is a chance that the stock you buy might hit your stop loss and start to move up in your expected direction. This happens due to short term fluctuations. I have experienced this many times. But we can manage this by taking the entry at a low risk point and put the stop loss at the swing low level.
Early exit
As said in the first disadvantage, due to trailing stop loss there is a chance that you might get out of the trade too early with minimal profit. But these are not big disadvantages. It will happen sometime but we can manage it.
That’s it, guys. I hope you get knowledge about stop loss from this article. If you have any questions please ask them in the comment. Please don’t forget to put stop loss when you take the trade.