Stop-loss orders are a common tool for traders to limit their losses and protect their profits in volatile markets. However, using them incorrectly can lead to unwanted outcomes, such as getting stopped out too early or too late, missing out on potential gains, or facing liquidation.
The principal reason stop-loss orders don't work is because stock prices aren't serially correlated. This means that what happened yesterday or last month does not necessarily affect what will happen today, tomorrow or next month. Past price movements of stocks do not determine future price movements.
A stop order typically ensures that your trade is executed, but it does not guarantee the price. It can provide protection during regular market hours, but in a volatile market, you have no control over the price you'll get and you may face a larger than anticipated loss.
A stop order is an agreement between you and your bank. You instruct the bank to make a series of future-dated repeat payments on your behalf. You can instruct the bank to cancel the stop order at any time.
When triggered, a stop order guarantees a transaction will occur but does not guarantee the price it will execute at. Alternatively, a stop-limit order guarantees the price a transaction will occur at but may not execute a transaction.
In case of extremely less volume, where there are not enough buyers and sellers (referred to as an illiquid contract), the Stop Loss will not be executed as the stock may not have enough buyers/sellers at a defined stop-loss limit price by you for the order to be executed which is also known as 'Market depth'.
Always sell a stock it if falls 7%-8% below what you paid for it. This basic principle helps you always cap your potential downside. If you're following rules for how to buy stocks and a stock you own drops 7% to 8% from what you paid for it, something is wrong.
If a stock price suddenly gaps below (or above) the stop price, the order would trigger. The stock would be sold (or bought) at the next available price even if the stock is trading sharply away from your stop loss level.
Limit orders are preferable to stop orders, because limit orders may result in positive slippage as orders can be executed at the requested price or a better price, while stop orders may result in negative slippage, as orders can be executed at the requested price or a worse price.
Therefore, in a rapidly moving market, a stop-loss order may not be filled at exactly the specified stop price level but will usually be filled fairly close to the specified stop price. But traders should clearly understand that in some extreme instances stop-loss orders may not provide much protection.
No Execution
A stop-limit order does not guarantee that the trade will be executed, because the price may never beat the limit price. If the limit order is attained for a short duration, it may not be executed when there are other orders in the queue that utilize all stocks available at the current price.
The disadvantage of this order type is that if the market sharply declines and the stock price is already below ₹94.90 when the trigger of ₹95 is reached, the Stop-Loss order remains open, potentially resulting in higher losses.
Stop-loss/stop-buy orders
If you want to buy or sell shares at the current price, you may be looking for a limit or market order. 🚨 Important: If you place a stop order for too close to the current price, it'll be considered a mistake and immediately rejected.
A stop-loss order triggers only when the market price reaches or exceeds the price you've set. If the market didn't reach your stop-loss price, the order won't be executed.
The Golden Rule is all positions must have a Stop Loss in place. Have the discipline to place a protective Stop the moment you've entered a position. Do not wait; the Stop should have been part of your trade plan. Only move Stop-Loss positions forward, never back.
The 3 5 7 rule is a risk management strategy in trading that emphasizes limiting risk on each individual trade to 3% of the trading capital, keeping overall exposure to 5% across all trades, and ensuring that winning trades yield at least 7% more profit than losing trades.
One popular method is the 2% Rule, which means you never put more than 2% of your account equity at risk (Table 1). For example, if you are trading a $50,000 account, and you choose a risk management stop loss of 2%, you could risk up to $1,000 on any given trade.
When the price drops or rises very fast, a market stop loss might execute at worse prices, and the limit stop loss might not execute at all. Check the next section to find out more about limit stop losses. Market orders are there to buy or sell something as fast as possible at the best available price right now.
What is an Invalid Stop Loss (SL) or Take Profit (TP)? Some of the most common reasons for an invalid Stop Loss and Take Profit include: Stops are too close to the opening price. Stops must be placed 2 pips away from the entry price. Stop levels are incorrectly formatted e.g. too many figures/decimal places.
Because your stop loss is always placed at an obvious price level where the smart money has the incentive to push the price higher, exit their trades, and then have the market reverse back in your direction. So the brokers are not really out to get you, it's just the way the market moves.
During volatile market conditions, these orders may be executed at prices significantly below the investor's price expectations (above for buy stops), especially if the market is moving rapidly. Another risk to consider is the fact that stop orders may be triggered by a short-lived, dramatic price change.
What stop-loss percentage should I use? According to research, the most effective stop-loss levels for maximizing returns while limiting losses are between 15% and 20%. These levels strike a balance between allowing some market fluctuation and protecting against significant downturns.
A sell stop order is entered at a stop price below the current market price. If the stock drops to the stop price (or trades below it), the stop order to sell is triggered and becomes a market order to be executed at the market's current price. A sell stop order is not guaranteed to execute near your stop price.