Using Stop-Loss Strategy For Stock Trading

A stop-loss strategy revolves around placing an order with a broker, or an online stock broker, to minimize the loss on a security position. Also known as a stop order or stop-market order, a stop-loss order allows the investor to determine their loss limit in advance. You can either buy or sell a certain stock when a specified price is reached. Then when that specific price is reached, the stop-loss order is entered as a market order, allowing the broker to buy or sell the stock at the current market price. For example, a stop-loss order of 10% below the stock price will limit the loss to 10%. Of course, the stop-loss order is a fail-safe although it is not completely accurate. A fast moving market may result in a slightly higher or lower stock price sale or purchase.

What are the pros and cons of using the stop-loss strategy for stock trading? The advantage of having a stop-loss order in place will allow investors to focus on other issues, rather than the constant, daily monitoring of a stock's performance in a stock market. This small but important factor clears up a lot of room, especially if you are worried about taking big losses. The disadvantage of this order is that simple daily market fluctuations for a stock can trigger the stop-loss, pushing you out of an otherwise good position.

Most savvy investors have different views on stop-loss orders. However, this strategy depends on what kind of investor you are. If your portfolio is well diversified with hundreds of positions, losses on a few specific positions may not matter as much. But if you're a single investor with a few positions, it could be a crucial step to protecting your capital.

Stop-loss orders are especially important for trend-following strategies. A large loss with a trend strategy could signify that the original entry signal has turned. A stop-loss order would minimize severe losses and preserve the investor's capital.

The overall benefit of a stop-loss order in most cases will outweigh the negatives. Since there are no costs, except for the commission when the buy or sell is issued, a stop-loss order essentially acts as an insurance against the opposite direction. Keeping in mind that stop-loss orders cannot be used for certain securities like penny stocks, picking a stop-loss percentage that allows for daily stock price fluctuations while preventing the most downside risk is a strong insurance policy that can protect your capital and profit with the upside.

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