How to Stop Loss in Share Trading

Stop loss orders can be useful to traders who want to limit their risk in the stock market.

The roller coaster ups and downs of the stock market can potentially cause investors to lose more money than they had anticipated. One way an investor can limit his exposure to unlimited losses when trading shares in the stock market is to use stop loss orders. Stop loss orders allow traders to set a specific price at which a particular stock they own is sold automatically if the stock declines to a certain point.

Instructions

1. Determine what percentage of your investment capital, or what exact dollar amount, you are willing to risk. If you have $5,000 to invest in a particular stock that is priced at $5 per share you may decide you only feel comfortable risking 20 percent of your capital, which would be $1,000. If that is the case, you would want to place a stop loss order at $4 per share.

2. Decide how long you want the stop loss order to stay in effect. When placing the stop loss order on your shares you must indicate if it is a "day" order or if it is a "good till canceled" (GTC) order. A day order will expire at the end of that trading day. A GTC stop loss order will stay in place until you instruct the stock broker to cancel it.

3. Calculate the stop loss price for short trades by determining what price you would have to sell to limit your losses in a rising market. Consider the previous example where the investor has $5,000 to trade a stock selling for $5 a share, and can only risk 20 percent for her capital. If she sold that stock short at $5, betting the price will fall, she would want to set the stop loss at $6 a share. In that scenario, if the market turns against her she will lose only $1,000.

Tips & Warnings

• If you set a stop loss order at a particular price, such as $20, and the market hits your price, your stop loss order becomes a market order for your broker to sell your shares at the best current price. It may be lower than $20.

• A widely used percentage for acceptable loss on a single trade is 2 percent of a trader's investment capital.

• Always trade with stop loss orders. It is the only way to protect investment capital from unpredictable market swings.

• If the market is moving against you and it appears that your stop loss order will be reached, resist the temptation to move the stop loss order to avoid being "stopped out." Doing so could potentially increase your losses.

References

• TradingPicks.com: The Stop Loss Order