Day64. Financial term | Stop-loss orders

When we engage in stock trading, we often hear the term "stop-loss orders."

A stop-loss order is a crucial trading tool that helps investors cut losses and protect their investment capital when stock prices decline.

In simple terms, a stop-loss order is an instruction to automatically sell a stock when its price reaches a level set by the investor. When the stock price reaches or falls below the set stop-loss price, the stop-loss order is triggered, and the stock is sold at the market price.

This way, investors can limit their losses, avoid holding onto losing stocks for extended periods, and protect their investment capital.

Setting a stop-loss order is highly flexible, and investors can set the stop-loss price based on their risk tolerance and trading strategy. Generally, investors can set a fixed stop-loss price, such as below a certain percentage of the purchase price, or based on technical indicators of the stock.

For example:

Suppose an investor buys a stock at $100 and sets a stop-loss order with a trigger price of $90.

If the stock price starts to decline, and it reaches $90 or falls below $90, the stop-loss order will be activated immediately, and the stock will be sold at the market price. This way, the investor can cut losses in a timely manner if the stock price declines to $90, avoiding further losses.

The stop-loss order acts as a defensive line for investors, helping them avoid emotional trading and excessive losses. However, it's essential to be cautious when setting stop-loss orders and not be overly aggressive to avoid premature triggering during short-term market fluctuations.

In addition, when it comes to stop-loss orders, you should also consider the following:

1. Set a reasonable trigger price: You should set the trigger price based on your risk tolerance and investment objectives. The trigger price should be reasonable and not too close to the current market price to avoid being triggered by normal market fluctuations.

2. Avoid frequent adjustments: Frequent adjustments to stop-loss orders can lead investors into the trap of overtrading and reduce the effectiveness of their investments. Give the stock enough time to develop and avoid excessive intervention.

3. Avoid using excessively tight stop-loss orders during high volatility: In highly volatile markets, excessively tight stop-loss orders may be triggered frequently, leading to frequent buying and selling and higher transaction costs.

4. Watch out for price fluctuations at markets open and close: Price fluctuations can be significant at markets open and close, which may lead to rapid triggering of stop-loss orders. Investors may consider avoiding setting stop-loss orders too close to the market price during these times.

In summary, stop-loss orders are essential risk management tools for investments, helping investors cut losses when stock prices decline to avoid excessive losses. However, when setting and using stop-loss orders, investors need to carefully consider their investment objectives and risk tolerance, avoid overtrading, and be cautious not to set orders that are too aggressive.

Additionally, stop-loss orders should be used in conjunction with other indicators to aid decision-making, rather than being the sole determinant of investment actions.