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Always be
Sure to Use Stop Loss Orders
Many
professional investors or financial advisors recommend that you should
always be sure to use stop loss orders. Many people though, do not fully
understand what exactly a stop loss order is. If you have a good financial
professional leading you through the decisions you are making while you
are trading stocks, surely they have at least discussed how important stop
loss orders can be. It is very important that new investors fully
understand what a stop loss order can do for them, and how you can use
them in investing whether you are a new trader or a very experienced
trader.
A very
basic definition of a stop loss order is a request to you place along with
an order to buy stocks on the market, which has your stock trader get out
of the deal after it reaches a predetermined loss that you didn’t
anticipate. Although it may seem hard to understand, it is actually quite
simple if you look at it in a basic way. Just say you don’t want to lose
more than ten percent of what you put in. If you are investing one hundred
dollars, this means once the value of your purchase gets down to ninety
dollars, you will be pulled out of that purchase and your broker will sell
it.
This can
be a great tool because you don’t have to make a decision on all the
stocks you may have purchased all the time. You can instead relax a bit
knowing that your trader will take care of pulling your money out of the
market when it reaches that point. Many people use stop loss orders all
the time, while other people just use them on certain occasions, like when
they are aware they will be unavailable or on a vacation and they don’t
want to be stuck watching the market or researching where their stocks are
at.
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The best
way to initiate using stop loss orders is to sit down with your broker to
have them explain the process and how best to do this. They may recommend
a certain percentage for all of your stocks or differing values for
different ones. The stop loss order can be a valuable tool to make sure
you don’t lose too much of your money, but it can also limit your
progress. Sometimes a stock takes a temporary nose dive, only to pull up
the following day. In this instance, you would lose out on the big
increase because of your concern for risk. Some people choose not to use
stop loss orders for this reason, because they know that they take the bad
risk along with the good risk.
Whether
or not you choose to use stop loss orders, it is good to think about how
much you are willing to lose up front, before you invest. If you haven’t
even considered this, it is smart to at least consider at what point you
would get out of a specific situation. Of course, this is very different
for every investor, so it is a personal decision that should be thoroughly
discussed with your advisor. Novice investors have a more difficult time
with this and are often a little too cautious, or a little too loose with
their decisions. Once an investor has a little experience under their
belts, these decisions are a little easier to make. If you are interested
in protecting your investments, always be sure to use stop loss orders to
make sure you don’t lose too much of your hard earned money.
Example Of A Sell Stop Order
Sell stop orders are placed by investors when concerned that a certain
stock they might be holding could drop in value, and they need to lessen a
loss, or lock in a gain.
In this instance of an example, say the investor has a stock valued at $40
per share, and they’d prefer to sell the stock in the case that it’s price
lessens by or more than 10%. In this instance, the investor would issue a
sell stop order at $40 minus 10% or $37. Should the stock's cost reach
$37, a conversion of the sell stop order takes place to a market order and
the stock is then sold at the next price available.
Example of A Buy Stop Order
An investor would usually place buy stop orders to take care of a short
sale. A investor that sells stocks short understand that the price of that
certain stock will decline. Should the cost of the stock decline, then
that investor has the ability to purchase the stock at the lesser price
and earn a profit. Yet, should that stock increase in cost, then that
investor would have to purchase the stock at a raised price.
In this example of a buy stop order, the investor orders at $40 per share,
that happens to be more than the current price of the market at $37.
Should the cost of the stock raise above $40, the buy stop order then
would be a market order, and the stock would be bought at the next cost
available.
Example Of A Trailing Stop Order
An investor would place a trailing stop order should they need to maximize
profit while the cost of a stock is increasing, and quell a loss should
the cost fall.
In this instance, an investor would put a trailing stop sell order into
effect to sell a stock priced at $40 per share with a $3 trailing stop or
a stop cost of $37. Should the stock cost drop to $38, then the order
wouldn’t be put through due to the stop price not being reached.
Should the stock's cost later raise to $50, then the trailing stop order
would be reset to $50 minus $3 or $47. Should the cost of the security
drop to $47, the trailing stop order would then be converted to a market
order, and the stock would be sold at the next cost available.
Example Of A Sell Stop
Order
Sell stop orders are placed by investors when concerned that a certain
stock they might be holding could drop in value, and they need to lessen a
loss, or lock in a gain.
In this instance of an example, say the investor has a stock valued at $40
per share, and they’d prefer to sell the stock in the case that it’s price
lessens by or more than 10%. In this instance, the investor would issue a
sell stop order at $40 minus 10% or $37. Should the stock's cost reach
$37, a conversion of the sell stop order takes place to a market order and
the stock is then sold at the next price available.
Example of A Buy Stop Order
An investor would usually place buy stop orders to take care of a short
sale. A investor that sells stocks short understand that the price of that
certain stock will decline. Should the cost of the stock decline, then
that investor has the ability to purchase the stock at the lesser price
and earn a profit. Yet, should that stock increase in cost, then that
investor would have to purchase the stock at a raised price.
In this example of a buy stop order, the investor orders at $40 per share,
that happens to be more than the current price of the market at $37.
Should the cost of the stock raise above $40, the buy stop order then
would be a market order, and the stock would be bought at the next cost
available.
Example Of A Trailing Stop Order
An investor would place a trailing stop order should they need to maximize
profit while the cost of a stock is increasing, and quell a loss should
the cost fall.
In this instance, an investor would put a trailing stop sell order into
effect to sell a stock priced at $40 per share with a $3 trailing stop or
a stop cost of $37. Should the stock cost drop to $38, then the order
wouldn’t be put through due to the stop price not being reached.
Should the stock's cost later raise to $50, then the trailing stop order
would be reset to $50 minus $3 or $47. Should the cost of the security
drop to $47, the trailing stop order would then be converted to a market
order, and the stock would be sold at the next cost available.
Stop Loss Orders Benefits & Risks
There are many significant benefits of stop loss orders:
Stock Cost Monitoring - since the order would automatically be set by the
movement of the cost of a stock, an investor doesn’t need to monitor the
cost per share on an everyday basis.
Price of Orders - there isn’t any price to place a stop loss order. A
commission would only be charged once the stop loss order's cost is met,
then the order would become a market order and the sale or buyout is
reached.
Trade Objectivity - stop loss orders can allow an investor to take away
all emotional ties to the stock of a company, and allows an investor to
trade based upon their strategy of investment or for each owned stock’s
goals.
There are also many significant risks of stop loss orders:
Cost Guarantees – when there’s an activation of a stop loss order, it then
becomes a market order. Within a rapidly dropping market, there will be no
guarantee that the selling cost would be identical to the stop cost.
Actually, it's usually different, and then the loss might be more than
anticipated.
Restrictions of Stocks - a dealer has the ability to not allow a stop
order to be put on some securities along with penny and / or Over the
Counter (OTC) stocks.
Fluctuations of the Stock Market - in a vicious market, a sudden and
unanticipated short-term raise or drop within the stock's cost can
activate the order.
Stock Market Crashes & Stop Loss Orders
This final example is a significant one due to the possibility that stop
loss orders could, and do, contribute to a fast stock selling during a
market crash. Actually, this instance is considered to have contributed to
the 2008 stock market crash. Once the cost of stocks started to drop in
October ‘08, stop loss orders were then activated, thus a surplus of
stocks flooding the market.
Once the stocks supply goes beyond the demand, costs would continue to
drop. This process of dropping costs and the automatic activating of stop
loss orders will then only add to the market's decline steepness. |
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