Stop-loss Order: Cap Your Losses

•6 min read•by Angel One

Stop-loss orders are a critical feature on the Angel One app that helps minimise downside risk! Read on to learn more about the mechanism and benefits of stop-loss orders.

Stop-loss orders are a vital part of the trading and risk management mechanism on the Angel One app. You may use them to limit your losses to a particular level when the market is facing a much higher level of losses.

Key Takeaways

A stop-loss order is risk management option through which traders can minimise potential losses.

Stop-loss order is an automatic one, which is executed when the trigger price is reached.

There are 2 types of stop-loss orders; market and limit, which are executed automatically when the criteria (trigger point) are met.

One major risk of stop-loss order is premature execution due to volatility.

What is a Stop-loss Order?

A crucial part of stop-loss orders is the trigger price. A stop-loss order allows traders to limit their losses by placing an order when a specific trigger price is reached. When the security price reaches the trigger price, the stop-loss order starts getting executed automatically, without the need for any human intervention.

There are two types of stop-loss orders:

Stop-loss Market Order: Only trigger price involved

In this case, once the trigger price is reached, the stop-loss order gets converted into a market order and gets executed as fast as possible at the best price.

Stop-loss limit order: Trigger price and limit price involved

In this case, when the security price reaches the trigger price, the stop-loss order gets converted into a limit order and gets executed at the limit price itself or a better price than the limit price.

However, one must remember that even if a stop-loss order gets triggered, there’s no guarantee of execution of the order if the price moves too rapidly.

How a Stop Loss Order Works?

A question most beginners ask is what is stop loss order? It is an automatic trigger for an order that exits an existing trade position to protect traders from facing sudden and heavy losses in the stock market.

In other words, stop loss is the safety net of a trader and must be used in trades to minimise losses. In this order, when a stock price reaches the defined price level during a reversal, the system exits the position without any manual intervention. Stop loss is a crucial tool in maintaining discipline while trading. It also eliminates human bias, emotional responses like greed and fear, and takes a prudent step towards risk mitigation.

Types of Stop-loss Orders

Knowing the types of stop loss orders is crucial in understanding the meaning of stop loss. The categories vary on the basis of trading goals, risk appetite and market fluctuations.

Fixed Stop Loss Order: This price level is set while taking a trade. Once this price level is reached, the trade is automatically executed. This is the simplest form of stop loss.

Trailing Stop Loss Order: A trailing stop loss is not set at a price but at a percentage or point gap. It limits losses during trend reversals while also locking in profits as the trade moves in favour.

Stop Limit Order: This variant of stop loss sets both a fixed price and a trailing stop loss. When the stop loss is hit, it converts the position to a limit order rather than a market order. This gives traders flexibility during volatile price actions.

All three types of stop loss orders are crucial for trading and traders can select the one that aligns the most with their risk appetite.

Also, read What is a Stop Order? Types & Advantages

Differences Between Stop Loss Order and Market Order

Difference	Stop Loss Order	Market Order
Definition	A stop loss in share market refers to an order that will exit a trade automatically to limit financial loss in a trade	Market orders are trades that are executed immediately at the current market price without any pre-set trigger.
Purpose	Stop loss orders are designed as a risk management tool that protects the capital by exiting a losing position	Market orders are placed to take a buy or sell position irrespective of the price movement.
Execution Price	Order is executed only if the triggered price is met.	These orders are executed at the available price and not at specific price.
Control For Trader	The stop loss order in share market allows the trader to take control of his risk to reward ratio.	Market order prices can change between order and execution of the trade, so the trader has minimal control one the order is placed.
Use	Typically used for risk management and protection from sharp price swings	Usually used to take quick positions.

Difference Between Limit Order and Stop Loss Order

Difference	Limit Order	Stop Loss Order
Definition	A limit order is an order to take or exit a position at a specified price. Trade is automated to buy stocks at a desired price only.	The meaning of stop loss in stock market is the order set with a price trigger, and is executed automatically once the price trigger is met. It a robust risk management system.
Purpose	It is designed to execute buy and sell positions at a decided price for booking better profits.	Stop loss is deployed to prevent excess financial loss by closing and open position during trend reversals.
Execution Condition	Order is executed only if the stock reaches the desired price.	Stop loss triggers as soon as it reaches the desired price, automatically converting into a market order.
Risk and Control	Limit orders offer control when the trade will be executed, but there is a possibility of missing an opportunity if the price is not reached.	The meaning of stop loss in stock market is partial control. It triggers at a set price, but the execution could happen at a different price. This can happen during steep swings.
Uses	Traders use this for exact entry price.	Stock market stop loss orders are recommended for any trader looking to limit losses and help with capital preservation.

Also, read Market Order Vs Limit Order

Advantages and Disadvantages of Using a Stop-loss Order

One of the biggest advantages of stop loss orders is the automated trigger during a trend reversal. It instantly exits a position when the price of the stock hits a pre-determined level to minimise loss and preserve capital. Since it can be executed automatically, the trader does not need to constantly monitor the performance. This allows the trader to save time while having a risk management strategy in place.

Stop loss orders also have some disadvantages. Sudden market volatility or short-term price fluctuations can prematurely trigger a stop loss, causing missed trading opportunities. If the price action is too swift, the stop loss may not get triggered, causing slippage. Traders must know the pros and cons to truly understand the meaning of stop loss.

Limitations

Stop loss order in share market is an important risk management tool but it has its limitations. The biggest limitation arises when a trailing stop loss is deployed. When the stop loss adjusts on its own during an uptrend, it protects the profit but it can also trigger a stop loss and exit a position. Sudden and short market swings lead to missed opportunity in trades. In some cases, the order may not be triggered due to rapid fluctuations.

Slippage is also a limitation in stop loss trading. Slippage means that a trade is executed at a different price than expected due to sudden market movement or low liquidity. This could lead to more losses. Traders need to account for unpredictable gaps up or down that could completely bypass the predetermined stop-loss price.

Conclusion

Stop loss is an extremely important tool for anyone wanting to trade in the stock market. It provides risk management, protects gains, and limits losses during volatile market conditions. Traders can select a stop loss type depending on their trading strategy, risk appetite and eliminate emotional biases while entering or exiting a position.

To use stop loss correctly, traders must consider slippage and sharp market swings that could trigger the stop loss prematurely.

Stop loss trading ensures discipline, mitigates losses, and builds a strategy, all of which are critical to sustain profitability for the long term in the stock market.

FAQs

What is Stop Loss?

Stop-loss order helps investors to try and minimise the loss in a trade. Some traders define it as an advance order, which triggers an automatic closure of an open position when the stock price reaches the trigger price level. Stop loss helps minimise losses but can also limit profits from a trade.

What is Trailing Stop Loss?

A trailing stop loss is an order that lets you set a maximum value or percentage of loss you can incur on a trade. If the security price rises or falls in your favour, the trigger price jumps with it at the set value or percentage. If the security price moves in your favor, the trigger price automatically follows it at the set distance. If the security price moves against you, the trigger price remains frozen in place, ensuring that the maximum loss you are willing to incur (or the profit you have locked in) is never reduced.

How does a Stop-loss get triggered?

Stop-loss can be your real saviour during a volatile market condition. A price level set at the beginning of the trade allows traders to close their position automatically when the stop-loss is reached. Squaring off takes place at the next price available at the trigger price level and helps limit losses.

What is the 1% rule of trading?

The 1% rule defines the maximum limit of risk one can take in a trade or the risk-per-trade. It implies adjusting your position so that total loss doesn't cross 1% of your trade value when the stop-loss is triggered. The 1% rule helps avoid significant losses.

Can I use stop-loss in trading with the AngelOne Trading app?

You can place a Stop loss order in AngelOne mobile app by following the below simple steps: • Visit the AngelOne app and select the stock to Buy/Sell • Select quantity of the trade • Set' Trigger price' • Enter the price where you want to place stop-loss • Confirm the stop-loss price, click on “Buy/Sell” and confirm the order

When I am trying to exit my position or place a Stop-Loss order, why is it being rejected?

It may happen if you have a pending Stop-Loss (SL) or an exit order already. With an already pending stop-loss or exit order, you will need extra funds to be able to place a duplicate SL/exit order. If you do not have this extra fund in your account, then your duplicate exit order will get rejected. That’s why we inform you while exiting if there’s a Pending SL/exit order against a position, to avoid any duplicate orders and rejections.

My Stop-Loss (SL) order was triggered but it did not get executed. Why did this happen?

There could be 2 major reasons behind this: The asset may be lacking a buyer/seller at the defined stop-loss limit price due to a lack of market depth. Orders are queued while they are being purchased or sold. For example: Let’s say there are 50 buyers and 100 sellers who are waiting to trade on a scrip at ₹90. Upon reaching ₹90, the first 50 sellers’ orders will be executed, and the remaining 50 sellers will have to wait for new buyers. In case you are one of those remaining 50 sellers, your sell order will remain pending if there are no corresponding buyers and vice versa. The price movement during high volatility does not fulfill certain criteria e.g. suppose you have placed a sell stop-loss with trigger Price at ₹100 and limit price at ₹100. Now imagine that the LTP touched ₹100 (here, the SL would be triggered) and quickly went below ₹100 due to high volatility. The limit price of ₹100 means the stop-loss order would get executed at only ₹100 or more. Now this order will be pending as price is below Rs 100 and execution will happen only when price has reached or crossed Rs 100. Hence your stop-loss order was not executed. Due to this reason, we recommend keeping a sufficient gap between the trigger price and limit price to increase the chances of Stop Loss execution during high volatility. Note: In order to increase the chances of execution, we keep the default value of the limit price 2 ticks away from the trigger price. This is done so that if the LTP moves rapidly after triggering the order, the limit price shouldn’t be a hindrance and the order should still get executed. Also, if you change the pre-set limit price and bring it closer to the Trigger Price, the chances of execution can reduce in cases of volatility.

My stop-loss order got triggered even though the predefined Trigger Price had not appeared. Why?

Chances are that the market price did hit the stop-loss price, albeit momentarily and without you being able to spot it at that moment. Within a second, prices can change multiple times and not all of them are relayed to the Brokers by Exchange, especially during high volatility. As a result, such momentary price fluctuations are not seen anywhere. Price matching and execution of the orders is done by the Exchanges and not the Broker.

My Stop loss order got triggered but it did not get executed?

The two main reasons your stop-loss (especially a stop-limit order) might not fill are:

Low Liquidity (No Match): There weren't enough buyers (or sellers) available at the exact price when your stop order was triggered. Your order got sent, but it just sits pending in a queue.

Price Moved Too Fast (Slippage Risk): The market was so volatile that the price blew past your limit price instantly after the trigger. Since your limit order demands a price "or better," it won't fill at the worse price and remains pending.

To increase your chances of execution, create a small gap between your trigger price and your limit price (e.g., let the limit price be slightly wider than the trigger). This gives the market some room to fill your order even if the price is moving quickly.

What is the 7% stop loss rule?

The 7% stop loss rule for traders is simple and straightforward - traders must exit a trade once the stock falls by 7% below the buying price. This helps protect the capital and limits the loss, especially during sharp trend reversals. This stop loss rule is not just a risk management tool but also a way for trades to trade with discipline.

What is the best stop loss strategy?

The best stop loss strategy is dependent on several variables such as risk appetite, type of asset, market trends, etc. Most traders end up deploying a percentage-based stop loss strategy. In this strategy, traders typically set up exit levels between 5%-10% of the stock’s buying price, common rule being 7%.

Some traders also deploy trailing stop losses, which move alongside upward trends in the stock price. Traders must combine technical analysis, study support and resistance zones for a robust stop loss strategy to minimise losses, and to ride volatile market trends with relative ease.

How to place a stop loss order?

Placing a stop loss order is simple. Once you are logged into your broker’s trading account, select the asset you want to trade. While placing the order, select the “stop loss” toggle. Enter the price at which the stop loss must trigger. This is the price the system will auto exit the trade if hit. Confirm all details and submit your stop loss order.

Should an investor set a stop loss order?

Yes, traders must consider setting a stop loss order in all their trades. It works as an effective risk management strategy. It offers a sense of security to the trader by automatically exiting a live position in order to minimise risk during price action trend reversals.

It is a tried and tested method of capital preservation and mitigating the chances of financial loss. It is not foolproof and comes with certain limitations, but a stop loss is prudent for sustained profits in the stock market.

What is the use of a stop loss order?

A stop loss order is an automated risk management system that allows traders to exit positions that are starting to make losses, with the emotion of fear and or guilt setting in. In case of a sudden drop in the stock, it takes a rational approach towards cutting off losses at the pre-decided limit, rather than traders making manual adjustments in a state of panic.

Stop loss orders allow traders to book profits in times of volatility by locking a certain part of the profit in a trailing stop loss. It gives traders the confidence to manage several open positions without the fear of great financial loss.