Stop Loss Order – Advantages and Disadvantages in Trading Stocks
Stop loss orders are not always advantageous though they are the most important tool for a stock trader. They have a lot of advantages but few disadvantages as well. Knowing them helps make best use of them in a given situation when trading stocks or exchanging shares.
Stop loss orders are not always advantageous though they are the most important tool for a stock trader. They have a lot of advantages but few disadvantages as well. Knowing them helps make best use of them in a given situation when trading stocks or exchanging shares.
Once you start trading stocks, you are on the wildest roller coaster journey you have ever been in your life. While riding on the roller coaster can be fun, riding on a stock market roller coaster is not really fun unless you are an exceptional trader who trades for the thrill it gives. There is money at stake. There is career at stake. There is life at stake. So you can’t risk such a ride.
Many amateur investors or stock traders stop trading shares soon after they hit bump in this roller coaster journey. Some more will stop after another bump. Few will persist no matter how many bumps they hit, because deep in them they believe that they can make it out of it. If you are reading this article, that means you are persisting to become a better trader. And stop loss order is going to be your most important tool in this stock trading journey.
Advantages of Stop Loss Orders
The advantages of a stop loss order can never be over emphasized. It is pretty simple. A stop loss order when followed consistently helps you cut losses short before they can big bang in your portfolio. They help you lock in profits when they are rather than just watch it get wiped out.
In the end as the time passes, trade after trade, you will see that you have preserved capital by taking small and timely losses, and appreciated capital by booking profits right after they reversed the trend. This is the most important benefit of using stop losses.
On the other hand, stop losses help you avoid spend time continuously watching the market. If you have other day job, you can do that without any stress or fear of a roller coaster ride your shares might be taking during the day, once you placed your stop loss order for the day. Without tension you can do your job well and also take better and clear decisions for your next trade.
Stop loss orders also help you avoid mental pressures that come when you choose to place orders using a metal stop in your mind. If you can remember from past trades, I am sure that you have had this experience. You avoid an automatic stop loss order thinking that you don’t like to take whatever amount of loss it is going to give. But you decide to place a sell order on the stop if the stock were to go down as you watch during the trading day. Later when it happens you will shift your stop a little down and continue to do so till the loss becomes bigger.
If the stock were to bounce it feels good and you will not forget that experience. But that is not important. If it were not to bounce, you will lose. Though you lose, you try to cover it up in your mind building up more tensions and irregular trading practices.
Using automatic stop loss orders helps relieve all these mental pressures and trade happily as long as you are willing to take a little loss only if the stock were to go down a support level.
Disadvantages of a Stop Loss Order
Along with the benefit you get from automatic stop loss order, you will also get little problems with it. The problem with it is that you might get wiggled out. That means a temporary fluctuation in the share price that happens just closer to your stop price could trigger your order and get it executed. Then it will bounce and define a new support just close to where you placed your stop thinking that was the best support.
These things do happen once in a while. But that does not mean you should not take advantage of stop loss order for what it is. Now the best way to avoid getting wiggled out is to either decide to lose little more in the event stock goes down further beyond support level or make a commitment to buy the shares back if the stock were to bounce back strongly after you are wiggled out.
This is the only true disadvantage of a stop loss order. But this too can be overcome with clever trading practices. Nevertheless given the huge benefits of avoiding big losses, stop loss orders should not be forgotten at any trade.
