Definition of the term Stop Loss.
Term
Stop Loss
Usage
Trading Term
Context
Answers questions: What does stop loss mean? Define Stop Loss. What is stop loss used for in trading?
Definition of Stop Loss
Stop loss is an action, manual or automatic, to buy or sell a security that has passed a limit set beforehand. This is typically done automatically. Many if not most brokerages in the market today offers stop loss orders. When the security reaches its stop price, the stop order made with the brokerage is entered as a market or a limit order for the preset price.
The limit order is usually set to a price below the trigger price (the price of the security that triggered the stop loss).
Example:
- We enter long (buy) security A at the price of 100.
- At the same time, we place a stop loss order at 96, to sell at 95.
- If the security reaches 96, an order to sell security A at 95 immediately hits the market, usually ensuring a successful sell of Security A.
The idea behind stop loss is to ensure that you don’t follow a loosing trade to the bottom. The drawback with stop loss is that if you are not an active trader, and if the market is in a bull market, you will inevitably lose money since not moving into a position fast enough will make you lose out on the re-bound.
Another drawback or risk with stop loss is to set it to tight, then missing out on the rally that was just around the corner.
Stop loss is greatly appreciated and gets a lot of ravings in literature. In reality, with a near 15 year bull market, for not-so-active traders, but rather private savings investors, a stop loss insurance on your order may only prove to be another way to lose money at both commissions and being stopped out just before the re-bound.
NOTE! This article does not take a stand on how you should act in any particular trade. Be aware of the risks with stop loss.