How do I use stop-loss orders to limit my risks?

Stop-loss orders are an essential tool for controlling potential losses in stock trading. They automatically sell your stock when its price falls to a certain level, limiting your risk. By using stop-loss orders, you can prevent emotional decision-making and reduce losses during market downturns, ensuring your investment strategy remains disciplined and aligned with your risk tolerance.

What is a Stop-Loss Order?

A stop-loss order is an order you place with your broker to automatically sell a stock when its price drops to a specified level. This helps you limit potential losses by setting a threshold at which you no longer want to hold the stock. Once the stock reaches the stop price, the order is triggered, and your position is sold off.

How Do Stop-Loss Orders Help Limit Risk?

Stop-loss orders help limit your risk in the following ways:

• Automatic Protection: They sell your stock automatically when it reaches a predetermined price, which prevents you from holding onto losing stocks too long.
• Prevents Emotional Decisions: Stop-loss orders take the emotion out of investing by removing the need for you to constantly monitor your investments.
• Reduces Large Losses: By setting a stop-loss order, you avoid suffering huge losses if the market moves against you quickly.
• Risk Management: Stop-loss orders help you manage your risk by ensuring your losses are contained to an acceptable level based on your strategy and risk tolerance.

Types of Stop-Loss Orders

There are different types of stop-loss orders you can use to manage risk:

• Standard Stop-Loss: The most basic type, which sells your stock once the price hits a predetermined level.
• Trailing Stop-Loss: This type moves with the price of the stock. If the stock price increases, the stop-loss price adjusts upwards. If the stock price starts to fall, the stop-loss order stays at its last adjusted level.
• Stop-Limit Order: This order includes a stop price and a limit price. Once the stop price is hit, the order becomes a limit order, and it will only be executed at the limit price or better.

How to Set Stop-Loss Orders Effectively?

To set stop-loss orders effectively:

• Choose a realistic stop price: Set the stop price based on your risk tolerance and the stock's volatility. A common rule is to set a stop-loss order 5% to 10% below the price at which you bought the stock.
• Don’t set it too tight: Setting a stop-loss order too close to the current price may result in the stock being sold off prematurely due to normal price fluctuations.
• Review regularly: Keep track of market conditions and adjust your stop-loss orders as needed, especially for stocks that have become more volatile.