Using A Stop Loss Order
Understanding what a Stop Loss Order is, how to use one, and when to use it must be understood by every stock trader or investor.
What is a Stop Loss Order?
This is a type of order that you set to be executed at a certain price or percentage point to help minimize potential losses. If it is set or adjusted once a profit is obtained on your position, it is being used to help protect profits as well.
It will also be important to understand that there are Advanced Order Types available that are a safer way to help minimize potential losses.
How To Use a Stop Loss Order?
Take a look at the blue circle towards the bottom of the chart shown below. On November 23, 2008 I sent out my Ezine to my free subscribers with some details about JEC along with reasons why I felt the stock could go higher.
The stock closed at $29.36 on November 21, 2008 and that weekend I wrote up my details and sent them out. I suggested the possibility to take a long position in the stock if it opened above the closing price of $29.36. On Monday November 24, 2008 JEC opened at $30.99 and went down to $30.28 before continuing higher.
If you were to have taken a long position in the stock at that time, you could look at the chart before you entered the trade, and see that the previous near term low was right around $26.00, 2 days earlier. Using a basic trading rule, you could have used a price point just below this level, say at $25.50, or $25.00 for your stop loss point.
The reason for doing this is that if you entered a position and expected it to go higher, and it then started to go lower and broke down below the previous lows, you should then realize that you may have been wrong in your outlook for this stock.
If you just bought the stock at $31.00 on the 24th, and it went down to $25.00, there is a high probability that it would also go lower than that. Without having a stop loss order in place you would wind up holding on to the stock all the way down, possibly to zero.
Now take a look at the bigger blue circle. You can see that from December 1st through December 5th, the stock was trading in a narrow sideways channel as well as bouncing off of its 50 day Moving Average (the blue line). This area was providing a bottom support level that the stock was bouncing up off of during this time.
You could have also bought the stock during this sideways channeling period using a point just below the red line I have shown somewhere around $37-$37.50 for a stop loss order.
As far as figuring out at what price point to use, that depends on your personal trading, style and rules that you have in place along with your position sizing and risk tolerance per trade being used. Using technical analysis will provide a way to find these points. What I have shown is an example of a common point for placing a stop loss using previous support levels.
You can use these levels on short term charts, long term charts or intraday charts. It is a good idea to compare charts showing multiple time frames to look for support levels.
If you were going to short a stock, you would then look for upper resistance levels instead of lower support levels.
So you can see that the Stop Loss Order helps minimize losses by taking any guesswork out of your trading. Have it planned out before you enter a trade and then follow through with it if it gets triggered.
The last thing I would like to explain, is the "when should I use it" portion. In my opinion, you should always use some type of Stop Loss Order. You may want to read that last sentence again, otherwise you may be back to this web page in the future saying to yourself that you should have remembered this part.