The Benefits of a Stop-Loss Order

07 June 2021 by Traders 360
Stop-loss order

As a self-directed investor, risk management must be an important part of your strategy. With your online brokerage platform, you can easily use different tools to maintain control over your portfolio without having to constantly stare at a screen. An appealing option to consider when trading stocks is that it is possible to limit your losses or protect some of your gains with automated sell orders.

What Is a Stop Order?

A stop-loss order allows you to schedule the sale of your shares automatically at a predetermined price. The main purpose of this type of order is to systematically sell your shares in the event of a drop in the share price.

The Advantages of a Stop Order

Since you aren’t always in front of your screen watching your stock prices, you may be surprised by a sudden movement in the price of one of your holdings. You may have already experienced a situation where you would have preferred to sell faster to avoid losses or to take profits. That’s why it’s important for self-directed investors to understand how to use stop orders.

On the one hand, a stop order allows you to set a selling price in the event that the share price drops below your purchase price. You can therefore use stop-loss orders to limit the maximum loss to which you are exposed. This type of order makes it easier to manage your emotions by determining in advance the price at which you will dispose of your shares. For some investors, this is a rational way to avoid significant losses by not hanging onto a stock that keeps falling.

Example of a stop-loss order at 63 $


* Source: Market-Q

In the example above, you can see that the stop-loss order at $63.00 allowed the investor to significantly limit their loss during this transaction. 
 

On the other hand, a stop order also allows you to protect some of your gains. Much like anchors for rock climbing, you can use stop-loss orders to prevent your profits from dropping to zero. By setting a sale price higher than your original purchase price, you can systematically secure a portion of your gains.

Example of a stop-loss order at 67 $


* Source: Market-Q

As shown in the image above, a stop-loss order protects a large portion of an investor’s profits if the share price were suddenly to drop back below $67.00. 

Conclusion

In short, stop orders can be an effective tool of risk management for self-directed investors who cannot track the price of their stocks in real time. Stop-loss orders can be part of your strategies and can be used to help you improve your returns. In addition, this type of order can also reduce the emotional component of the transaction by requiring you to stay true to your initial analysis with regard to your risk taking. In the end, it may be beneficial to use stop orders when you trade on the stock markets yourself.
 

Author’s biography: Alexandre Demers has been an active investor since 2013 and is the founder and president of Traders 360 Inc. He has also authored the e-book “Investir à contre-courant” (Investing against the grain) and hosts the “Finance 360” podcast available free on Spotify and iTunes. His goal is to make stock trading more democratic and educate the public at large about the possibilities of self-managed investments.

The above article was written by Traders 360, an independent external firm partnered with National Bank Direct Brokerage.

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