A stop-loss order (in Spanish, stop losses) is a stock order that is intended to stop losses in case an asset suffers a sudden collapse. The order, which remains activated but not executed, is activated and executed, ordering the sale of the asset, when the price of said asset is located at the level previously established by the investor.
When we set a stop loss, what we are doing is limiting our losses. In this way, we can tell the broker that, in case the stock we have bought, and for which we have paid 100 dollars, drops to 70 dollars, the operation is closed immediately, avoiding the losses that would entail keeping the operation as long as its value is plummeting.
In the same way, we could also set a stop loss in the case of having acquired an asset, which has already experienced a revaluation. Let's imagine that we bought it for 100 dollars and today it is worth 800 dollars. In this case, we could set a stop loss at 780 dollars, ensuring the profit already harvested against possible sudden collapses.
As its name implies, this type of order serves to limit losses,
But if it is still not clear to you, I leave you a video so that you can review it before continuing:
Stop loss and take a profit
On the contrary, we also have the orders take profit. In this sense, orders behave opposite to stop loss.
In the take profit orders, what we are doing is limiting the gain. That is, setting a profit limit so that, as soon as the asset reaches that price, the operation is closed, guaranteeing a previously expected profitability. In this sense, let's imagine that we expect an asset that is worth 100 today to appreciate, its price reaching 160 dollars.
To ensure the gain in case this asset appreciates, and like with stop loss, we set a take profit, which will be executed as soon as the asset price reaches the price previously established by the investor.
Characteristics of a Stop Loss Order
Among the characteristics that define this type of stock order, it is worth mentioning the following:
- The financial entity will attend to the requests to lower stop loss orders, as long as the order situation allows it.
- A stop-loss order cannot be modified. In that case, the order must be canceled and a new one must be processed with the new conditions.
- It is not possible to send a stop loss order “at the market” or “limited to the best price”. It is, therefore, necessary to inform a limited price.
- Stop loss trading is available for securities and warrants quoted on the continuous market, as well as for the securities that make up the main international indices.
- Retentions derived from a high stop loss order will not be made, as in the case of a normal order, when it is registered, but when the activation condition is met and sent to the market. This is the reason that allows the investor to register more than one stop loss sale order on a single purchase.
Types of Stop Loss Orders
Among the main types of stop loss that we find, we can highlight three types, with some subtypes:
Among the types of stop-loss static that we find, we can highlight the following:
- Stop Loss Sell
The most frequent of all.
This stop loss is a sell order that, following the recommendations of the chartist analysis, forces to sell if the quotations go down and a predetermined level is lost.
“Stop loss” can be translated as “stop the losses”, and it is placed, in this case, below the support levels or accumulation of demand. According to the chartist analysis, the loss of one of these levels is the beginning of a prolonged fall in quotations.
With the stop loss, we sell before the prices sink definitively, thus avoiding greater losses. It is based on one of the basic principles of investment in the financial markets which is “learn to lose, to assume losses and to limit the amount of them”.
- Stop Loss Buy
The stop loss, in this case, is a buy order.
In this case, it is activated when, having been in selling positions, at a certain moment a movement in the market is produced consisting of the break upwards of a predetermined resistance level.
With this, we want to avoid being able to remain uninvested in a wide bullish movement of a certain financial asset, thus depriving us of the possibility of obtaining important benefits.
Among the types of stop-loss dynamics that we find, we can highlight the following:
- Stop Loss Dynamic in Buyer Position
An ascending stop loss serves, in the case of having guessed the price movement in buying positions, to squeeze the profits to the maximum possible.
For this, we will use this stop loss in the case of a buying position that enters into profits. If we have bought and the price of our shares is going up, we will incorporate an ascending stop loss, so that we can consolidate the profits obtained. For this we will study the previous behavior of the action and its supports.
The issue is to go up the stop to get out of the value as the price goes up. In this way, not only will we ensure the benefit, but in the same way, a sudden drop in the quotation will not surprise us.
- Dynamic Stop Loss in a Selling Position
A descending dynamic stop loss serves to keep us in this position for as long as possible in the case of having correctly predicted the price movement in selling positions.
To do this, we will use this stop loss in the case of a selling position that is in profit. If we have sold and the price of our stocks continues to drop, we will incorporate a descending stop loss to protect the accumulated profits. To do this, we will study the previous behavior of the stock and its resistance.
The issue is to lower the stop loss in order to enter again later, as the price decreases. In this way, we will ensure the profit in the face of a sudden increase in the quotation.
Guaranteed stop losses are those that we use when we know for certain the value at which an operation will be closed, we set the stop loss in the position, and we pay a premium afterward that will guarantee the premium; thus avoiding risks derived from a possible slip, for example.
In any case, this can be changed for another, static or dynamic, depending on our interests.
How to Configure or Apply a Stop-loss Order?
A stop loss order will be activated when having fulfilled the activation condition, the reported price of said value changes. In fact, in very illiquid stocks (which have little trading), where trades are not continuously crossed in the stock market and the quotation of the value does not change at every moment, it may happen that the order is not activated instantly, despite the fact that the activation condition is in price.
Understanding this mechanism is simple if we take into account, for example, that within the sale stop the risk of the investment will be managed, sending two sale orders: one that limits the losses, and another that sets the profits.
Putting ourselves in the case of an investor who has bought 500 shares of a value, of 35.50 euros each, and analyzing the situation of the market and the expectations of profitability, it will be decided that the objective profitability is 8.50% on the investment, and that the maximum loss that is willing to assume is 3%.
In this case, it would be necessary to issue a sale order stop loss that contemplates maximum losses of 3%, for which it should limit the sale to 34.44 euros, with a condition of activation less than or equal to 34.46 euros per share. The sale ‘stop' order for profits, on the other hand, will be limited to 38.52 euros (the equivalent of + 8.50% of the profits contemplated), with a condition of activation greater than or equal to 38.52 euros.
As can be seen, there is a small quotation offset between the limited price and the activation price. It is due to the fact that the recommended activation price is slightly higher than the limit price in order to ensure the execution of the order at a price, at least equal to the limit price, in order to obtain the desired profitability.
Example of stop loss
To finish, let's see a simple example of how these tools work.
Let's imagine that we want to buy 100 shares of Apple, and we issue a purchase order that will be executed when they reach a value of 25 euros per share.
If the order is executed and we already have the shares, we can set a stop loss so that, in case of a sudden drop, the position is closed at the moment the share reaches 20 euros.
In this way, we already know that by setting this stop loss, the maximum loss we are assuming is 500 euros. Well, if the operation closes at 20 dollars per share, the calculation (5 € for 100 shares) tells us that we would lose up to a maximum of 500 euros.
How does a stop-loss order protect my investment?
Setting a stop loss ensures that your broker will sell your asset if its price reaches the predetermined level, preventing further losses.
Can a stop-loss order be applied to profitable trades too?
Yes, it can secure profits in the case of an appreciating asset, setting a limit price to exit the market when the desired profit is reached.
What are the types of stop-loss orders available?
The main types include static (stop loss sell/buy), dynamic (ascending/descending), and guaranteed (certainty in value) stop loss orders.
How do I configure a stop-loss order?
Choose a price level for stop loss activation (activation price) and set the limit price for selling the asset (limit price) to manage risks and gains.