A stop-loss order is an instruction to sell an investment if the share price falls to a set price, allowing investors to control potential losses and lock in profits. It reduces the need for manual monitoring and emotional sales decisions, but investors must understand short-term fluctuations to maintain long-term investments.
In finance, a stop-loss order is an instruction with a stockbroker to sell an investment in a stock automatically if the share price falls to a set price. The primary purpose of a stop-loss order, or stop order as it is sometimes called, is generally to control the investor’s loss and protect him from sharp declines in stock prices. An experienced investor may buy stocks with the goal of earning a certain percentage of profit, and may also have a limit to the loss that he is willing to risk taking on the trade. The stop-loss order allows the investor to control the amount of potential loss he or she would make on the trade if the share price were to fall.
Some of the advantages that investors can gain from using stop-loss orders include the ability to control or minimize the loss, a reduced need for the investor to manually monitor their investments, and the provision of a method to set a sell price for a declining stock. and stick with it while reducing the emotional element of the sales decision. Typically, a brokerage order for a stop loss does not incur any additional fees above what the investor normally pays for trading in the stock market. Due to these advantages, stop-loss orders are often recommended to beginning investors as a very important tool to reduce potential losses.
In addition to limiting losses, a stop-loss order can be used to lock in profits. If an investor has bought a stock at a particular price and then the value of the stock has risen, he or she can set a stop-loss order at a point lower than the current market price but higher than the original price at which the investor bought the stock. When the price of a stock continues to rise and the investor moves their stop-loss order along with the price, this is called a trailing stop.
There are some restrictions and disadvantages that can be encountered when using stop-loss orders. It is important for the investor to have some understanding of the short-term fluctuations the stock is likely to experience, in order to allow for them while maintaining the long-term investment. For example, if a highly volatile stock typically fluctuates by 5% on a daily basis, then a stop-loss order to sell if the stock falls by 4% may not be an advisable strategy.
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