Defining a Stop Loss

If you are day trading in any form whatsoever, the first thing you should be doing is defining and managing your risk. One of the most common ways to do this is to make use of a stop loss order.

Automated risk protection

There are several types of orders you can place with your broker. A stop loss is one of them. If you put in this type of order with your broker, once the price hits a predefined level, your stock will be automatically sold. The most common use for this type of order is to prevent losses.

You can use a stop loss order so you don't have to keep watching your stock day in and day out. This is especially useful if you are not around to sit on front of your computer all day. We all have responsibilities that don't relate to day trading such as vacations and family issues.

You must use a stop loss correctly

If you use the order incorrectly, it can negatively affect your trading. For example, if you place it too close to a supporting trend line, the stock price may temporarily cross that line, thus triggering your stop. The stock may then continue on to its original trend leaving you with unrealized profits. It is best to leave some wiggle room when deciding what price to set your stop loss at. This will depend greatly on how much risk you can absorb, as well as the exact rules of your trading plan.

Same as a market order

Although the order is called a stop loss, in reality it is simply a market order that gets triggered automatically. It does lower your risk in the markets, however, a market order does not guarantee the best price in any given stock.

It doesn't have to be automatic

Your stop does not necessarily have to be an automated order. You can have a mental stop loss instead. Of course you will have to be watching the markets closely. When you see that the price has crossed your stop, you can then put in a limit or market sell order. Whether your order is automated or not, the principle of a stop loss remains the same.

There are many things you can do to limit your risk in the stock market. A stop loss is definitely something that should be in your arsenal. Your risk will be greatly minimized and you'll be better off as a trader in general.