Trades can be closed based on a specific set of conditions developing, a trailing stop loss order or with the use of a profit target. A profit target is a pre-determined price level where you will close the trade. Multiple investors do not know what to do in order to protect themselves within the stock markets. It’ll come as no surprise: all self-proclaimed gurus claim to possess the perfect strategy since sliced bread. What those “gurus” do not offer is free details.
There are, fortunately, many easy strategies which you may use to shield yourself from downside risk within both bear and bull markets. In this post, we’ll cover sell-stop limits, sell stops, buy-stop limits, buy stops, as well as techniques and tips on how to effectively place them in any kind of market. But let’s start from the very beginning.
1. What is a Stop Order?
Every trade requires an exit, at some point. Getting into a trade is the easy part, but where you get out determines your profit or loss? That’s where a stop order might help you.
A stop order, also referred to as a “stop”, is an order to buy or sell a security when its price moves past a particular point, ensuring a higher probability of achieving a predetermined entry or exit price, limiting the investor’s loss or locking in a profit. Once the price crosses the predefined entry/exit point, the stop order becomes a market order.
There are different types of stops, including buy stop orders, sell stop orders, stop market and stop-limit. Stop orders are used to limit losses with a stop-loss or lock in profits using a bullish stop.
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2. Buy Stops and Sell Stops Cap Losses
One method of protecting the downside within the markets is with the use of sell stop limit orders and sell stops. Sell stop orders, oftentimes referred to as stop-loss orders, are orders to sell a stock as it reaches a specific price. If a stock reaches that stop price, the order then is executed and shares will be sold at the marketplace price for that stock. As the order is to sell, a stop always is placed under the stock’s market price.
Stop-limit orders are orders to sell stocks as a certain price is reached, so long as the price doesn’t dip below the limitation specified by an investor. If a stock reaches the stop price, an order is converted to the limit order. The advantage of a limit order is that you’ll possess more control over a price at which a sell is executed.
With both kinds of orders, if a stock does not reach a specified stop price the order won’t be filled.
3. Putting Stops into Place
The correct use of sell stop limits and sell stops are key to shielding investments. Those tools keep the process of decision-making unemotional and simple – even as the market is in turmoil. Also, they assist in preventing you from rethinking when you should take profits and when to hop ship on quick-sinking stocks.
As there isn’t any percentage or magic number utilized to set stop orders, usually there are a couple of common techniques utilized to place them:
- Place your stop price under the support level. It’s possible to identify a support level by checking out a chart and locating the lowest points for a stock and prior points where it ceased in dropping. A break under this point generally would mean that there’s a possibility that the stock might go lower.
- Place the stop price 5- to 15 percent under your purchase price, depending upon your comfort level. It’ll keep you from riding the stock all of the way down and assist in keeping your losses manageable. Additionally, knowing what the downside is permits you to decide (and get ready for) the worst-case scenario.
Plus, you may adjust the stops upward as a stock moves up by checking out the point in which it previously stopped dropping then setting the sell stop limit or sell stop right under that level.
4. How to Keep from Being Stopped Out
As the stock dips to the sell stop price you set and shares are sold, it’s called being “stopped out”. Therefore, while sell stop limit orders and sell stops are an excellent method of keeping you on the proper side of the markets, there’ll be occasions when you may hit the sell stop limit or sell stop right before the stock begins an additional ascent.
How might you avoid this? As a general rule of thumb, you should avoid placing stops at a round number like $36 because most traders place their orders at round numbers. As a stock hits the round number, it’ll trigger one final selling round. The key to selecting a more successful stop includes placing the order at an odd number with an adequate amount of room to account for the final possible selling round.
5. For the Short Seller: Buy Stop and Buy Stop Limit Orders
If you’re playing the market’s short side, a buy stop limit order or buy stop order may be utilized to shield your downside if a position suddenly moves against you.
Buy stop limit orders and buy stop orders may be utilized to protect a loss or profit on short sales. Short sales are the act of selling stocks you do not own with the objective of purchasing stocks back at a reduced price in order to make a profit. If your stock rises, you purchase it back at an increased price in order to create a loss. Buy stop orders are utilized to limit losses or protect profits on short sales and are entered above market prices. As a stock reaches the price, the trade will be executed at the market price.
Buy stop limit orders are orders to purchase stocks once a certain price is attained, at which point an order will convert to a limit order. A buy order will just be executed at a specified limit price or higher.
6. Setting Up Buy Stop Limits and Buy Stops
Similar to sell-stop limits and sell-stops, placing buy-stop limits and buy-stops may be tricky. Thankfully, there are applicable general rules to where they ought to be placed:
- You may place them right above a stock’s resistance level. It’s the point in which a stock struggles in moving higher. The level forms as investors buy massive quantities of a stock right before a dip with the idea that you should sell it as it again hits this point.
- You may place them around 10 to 15 percent above the place you initiated a short sale if the position is volatile. Also, these may be adjusted downward to shield profits by searching the highest point a stock reached on the prior rally.
7. How you can Avoid Hitting the Buy Stop Limits or Buy Stops
Similar to sell stops, you should avoid hitting the buy stop and getting the position to drop off as the short position is covered. Lots of the same methods you use on sell stop limits and sell stops also can be applied in this case. They involve avoiding round numbers and placing buy stop limits and buy-stops at odd numbers instead.
As the stock hits the buy stop limit or buy stop, you’ll have a few options:
- Wait and see how your stock trades.
- Go back in and then place an additional buy stop limit or buy stop to protect the downside on the short.
What you opt to do at this phase, however, depends upon your overall comfort level.
8. In Summary
It’s clear that by utilizing sell stop limits, sell stops, buy stop limits and buy stops, traders may shield themselves from volatile markets, as well as prevent huge portfolio losses. With that said, you ought to adapt the method in which you use those tools to your level of comfort. If you prudently use them, they ought to keep you on the proper side of the market.
