Stop loss in trading is a method that is used by traders to limit their losses. One should generally place a stop loss below their entry level, when they are buying the stock and above the entry level while short- selling the stock.
Support and resistance levels , Technical Indicators , Fibonacci retracement / extension levels or simple percentages are few common methods to place a proper stoploss.
The importance of putting a stoploss before entering into a trade cannot be denied by any trader.
- Helps in Cutting our losses: Stop loss in trading helps us to minimize our losses and also ensures us against a big loss. Many times, the trader suffers a big loss if he doesn’t place a stop order as the price falls steeply.
- Provides Automation: Stop loss in trading helps to automate our squaring off the position which prevents to be present in front of our trading screens all the time. A stop-loss automatically gets triggered if the stock touches a specific price.
- Helps in maintaining ‘Risk and Reward’: One should maintain risk and reward while trading.
- Disciplined trading: It’s important to detach oneself from market emotions. Stop loss helps to stick to your strategy and also promotes disciplined trading.
Let's discuss some common mistakes which should be avoided when you Place Stop Loss:
- Not Determining your Stop Loss Placement in Advance: A trader should know where his stop loss is going to be before he takes the position. The benefit of ascertaining your stop loss before you open trade is that it removes any emotions from the decision.
- Placing your Stop Loss Based on Arbitrary Numbers: One shouldn’t place their stop loss based on arbitrary numbers. They should determine their stop loss based on technical parameters as discussed above.
- Avoid putting stop losses on exact support or resistance levels as the chances of getting hit is higher. It could be placed a few ticks above or below the level.