Stock investing means risk, which you can control. Instead of simply plunging in with money you might not be able to lose, you can protect your stake with a stop loss order. Experienced investors always use stops, and those who don't will sooner or later regret their oversight. The stop loss is a simple but effective device that should protect you in the case of an unexpected turn in the market.
A "stop" in investment lingo is an order to sell your investment if it falls to a certain level, at which point you no longer wish to risk further loss. You can place stops when you buy or sell short, which means putting the stop above your entry point. Trading software and online platforms will send the order to close out the trade instantly when the price gets to it. You don't have to constantly monitor the stock, and you limit your risk.
You can place the stop wherever you feel uncomfortable risking further capital. However, you must consider the constant price fluctuations in the market, and the fact that stocks -- and other investments -- are subject to price swings in the normal course of market business. Thus, if your stop is too close to your entry, you might get "stopped out" at a point where the stock just took a temporary dip and then recovered. This can lead to a series of small and pointless losses. If you place the stop too wide, you might be allowing an unacceptable risk.
The percentage loss you're willing to take on an investment is a personal matter. Many investment advisers offer you hard-and-fast rules, such as to place a stop at a swing of 10 percent, meaning if you bought at 100, you'll get stopped out at 90. But if you believe the investment's a good one, the price is just bound to fluctuate and you can take the risk, you can place a stop at 20 percent, 30 percent or 50 percent. This gives your stock room to roam, and your investment time to absorb some losses while you hope for an eventual profit.
Limit Orders and Rising Stops
The opposite of a stop loss is a limit order, which closes your trade at a preset level of profit. If you've done well and want to aim for an even better profit on a rising investment, you would place a limit order above the current price. The percentage at which you set the limit is entirely up to you; the closer to the current price, the sooner the order is likely to fill. An alternative would be to keep setting the stop-loss higher as the price rises, locking in your gains. Once the price has cleared your entry point, setting a stop-loss at that price guarantees you won't lose on the trade.
- stock market crash image by Paul Heasman from Fotolia.com