Buzz
Safeguard your investments with a stop-loss strategy. This tactic automatically sells your stock when it hits a predetermined price point. Once triggered, the stop-loss becomes a market order, ensuring execution but not price certainty. Its purpose is to mitigate losses in the stock market. However, be aware of scenarios where a stop-loss might backfire. While some exchanges no longer support stop-loss orders, your broker may offer similar protective measures.
Steps to Follow
Implementing a Stop-Loss Mechanism
Master the Essentials: A stop-loss is a vital tool in your brokerage arsenal, guarding against market downturns. It automatically triggers a sell order if stock prices dip below a specified threshold. The logic behind it is simple: if prices are falling, they're likely to continue falling. By setting a stop-loss, you cap potential losses. For instance, imagine owning a stock valued at $30 per share and wanting to sell if it drops by 10% or more. You'd set a stop-loss at $27. Once the stock hits $27, the stop-loss converts to a market order, ensuring prompt execution at the prevailing price. You can also set a timeframe for your stop-loss, cancelling the order if the stock isn't sold within the specified period. Whether it's a day order or a GTC (good 'til cancelled) order lasting 60 days or more, utilizing a GTC order can save you the hassle of renewing your stop-loss order.
Determine the Stop-Loss Price: Examine a stock's daily ranges on a chart spanning six months to understand its highs and lows. Set a stop-loss between 3% to 7% of the median trend line. For more insights, refer to 'Technical Analysis of Stock Trends' by Edwards and Magee.
Execute the Stop: Navigate to your online brokerage's trading section. Opt for a stop-loss order instead of a market order. Specify the price at which you wish to set the stop-loss order.
Stay Calm: Once the stop order is in place, your broker will monitor the stock and execute a sale if it hits the predetermined point. If the stock rises or remains stable, the stop order remains inactive.
Minimizing Losses with Stop-Loss Strategies
Analyze Past Stock Performance before Setting Stop-Losses: Failing to do so may result in being 'whipsawed,' where a security's price abruptly reverses direction. You might sell at a loss only to witness the stock rebound without your participation.
Beware of Gapping Stocks: Avoid stop-loss orders for stocks that experience 'gaps,' where the closing price exceeds the next day's opening price. Overnight drops could surpass your trigger point, leading to unexpected losses or reduced gains. Exercise caution with stop orders for volatile stocks like small-cap or low-volume stocks. Analyze a stock's daily chart to identify its gapping tendencies.
Manage Day Orders: Day orders, a specific type of stop, expire at the end of each trading day if not triggered by then. You'll need to renew such orders daily if desired.
Assessing the Pros and Cons
Weigh the Advantages of Stop-Loss Orders: With automatic triggers based on stock price movements, you're relieved of daily price monitoring. Placing a stop-loss order incurs no upfront costs; brokerage commissions apply only upon execution when the order becomes a market order.
Consider the Drawbacks of Stop-Loss Orders: In swiftly declining markets, the selling price may differ from the stop price, resulting in larger losses. Some securities, including Over the Counter (OTC) and penny stocks, may not permit stop orders.
Adjust Your Approach to Stop-Limit Orders Based on Your Risk Tolerance: Utilize stop-limit orders during volatile market conditions to safeguard your investments. They act as a protective measure against significant losses. Typically, set your stop-loss order 5 to 10 percent below your purchase price to mitigate potential losses. Adapt by raising your stops if the stock price shows an upward trend.
