Setting Stop Limit Loss - Your Trading Safety Net
By Ultimate Trading
The Reasons For Using A Stop Limit Loss Order
The markets will not keep your money safe. Though this is a
well-known fact, many people find it quite hard to understand. They
believe that, no matter what, the market and "good stocks" will
"always come back," as though this were a law.
But there's no such law. Stocks don't always come back, and neither
do markets. If you want to think about the market in terms of laws
of nature, the best one is the law of gravity, specifically: "What
goes up must come down." This is especially true for stocks and
sectors that have risen extremely quickly. You can protect your
capital, and your profits from this natural market law by setting
stop limit loss.
A stop limit loss is an order you place to sell or buy a position
you own if it hits a specified price. It's called
stop limit loss
because it stops you from losing any more money on the position. If
you've sold short, you can place a stop order to buy to cover if the
stock rises to a specified price. Stop limit loss is not complicated
to use, and they are an integral part of trading success.
When we use the word "stop," were referring to a stop limit loss
order. This is an order that directs your broker to sell a position
you hold if the stock drops to a specified price. If you've sold
short, you can place a stop limit loss buy-to-cover order to get out
of the position if it rises to a specified price. Once the stop is
triggered, it's immediately executed as a market order.
Here's an example. Let's say you buy a stock at $50 a share. You
have reason to think it will rise, but you also realize it's a risky
trade. You know that if the stock drops below $48.50, it means
there's trouble with the trade and you'll want out. So, after buying
the stock, you place another order: a stop sell order at $48.40.
This tells the broker that if there is market action at $48.40, or
below, to sell your shares immediately in the form of a market
order. They'll be sold at the current bid, whatever that is. This
will happen automatically, so you won't have to watch the stock
closely. It also means you won't be tempted to hold on longer,
hoping that the stock will go back up.
A stop limit loss order is an order to sell a position at a specific
price and no lower than that price, if the stock drops to that
price. Or to buy to cover a stock sold short at a specific price and
no higher than that price if it rises to that price. Once the stop
limit loss is triggered, the order is executed only if it can be
executed at the limit price or better, it becomes a limit order.
Let's say the stock from the earlier example does drop. It hits
$48.40, and the stop limit loss is triggered. The stop limit loss
order becomes a market order to sell. This means that it will
execute immediately at the current bid price. The same principles
apply to stops on short positions. If you sell a stock short at $13,
expecting it to go down, you should place a buy-to-cover order at,
say, $13.75. If the stock suddenly rises sharply, you're protected -
and you can always re-short the stock at its peak price later.
Let's go back to the stock the trader bought for $50. If the stock
is falling slowly, the market order may execute at $48.40, slightly
lower, or even, occasionally, slightly higher. If it's falling
quickly, it could execute a little below $48.40. If the stock is
falling very quickly, it could execute well below $48.40.
The possibility that they could be stopped out of a position far
below the trigger price is one reason traders may avoid using stop
limit loss. Although this could happen, its better than the
alternative, to keep holding the position while it goes even lower.
Besides, in most cases the position will be stopped out quite near
the trigger price. In addition to fearing a bad execution price,
some people are afraid that the position will start to go back up
immediately after their stop limit loss has been executed.
A stock may occasionally bounce right at the point where you set
your stop limit loss, as a random occurrence. But the smart trader
weighs this rare frustration against all the times hell save much
more money by using
stop limit loss
to get out of losing positions. Think of it as the cost of
insurance. Using stop limit loss as insurance will occasionally cost
you a little, but it will save you many times more in the long run,
and you dont often get a chance to insure against a law of nature.
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Stop Limit Loss