Most people consider trading to be risky since stock markets are volatile. However, the stock market is bound to be volatile, and that is how traders make a profit out of it. Imagine a stock market that moves daily in the same direction and by the same margin. Will that help you earn any extravagant income from the market, no right? That said, this volatility, if not understood and analyzed properly can lead to losses as well. Though the risk is inevitable in the stock market, a stop-loss order is a thing in trading that can help you to a great extent in a volatile market situation.
What is a stop-loss order?
A stop-loss order can be referred to as an automated order which helps in minimizing the losses of a trader on their orders. Stop-loss closes the position when a specific price of security is reached. For instance, if you set a stop-loss of 5% below the purchase price of the stock, then it will limit your loss to only 5%. So, suppose you purchased the stock at Rs. 2000, and you want to sell it for Rs. 2100 per stock, and the current market price is Rs. 2050. The maximum loss you can bear is up to Rs. 100, so you need to set the stop-loss at 5% and the selling price at Rs. 2100. Now, if the price moves up to Rs. 2100, then your order will get executed, and you will make Rs. 100 profit on each share. However, if the stock price moves down to Rs. 1900, the stop-loss will close the position and sell the stocks at Rs. 1900, and this will reduce the chances of making a bigger loss.
When are stock markets considered to be volatile?
Stock markets can be considered to be volatile when prices move more quickly than usual, and if the stock prices are reaching new highs and lows very quickly, then the stock market can be considered to be extremely volatile. While volatility is required in the market to make profits, however, extremely volatile markets are highly risky. This is where stop-loss comes in.
How does stop-loss help in volatile market situations?
When markets are highly volatile, prices move so quickly that even if you monitor them, placing the trading order with the right price becomes highly difficult. Moreover, if you try to trade at the market price when the prices fluctuate heavily, it can lead to heavy losses. However, with the help of stop-loss, you can strategize your trades.
Even if the markets are moving quickly, if you have a stop-loss in place, whenever the price reaches the strike price or breaches it, the order gets executed. This helps the traders in multiple ways. The traders do not have to monitor the trades or the market continuously. You can set the stop-loss in place, and then it will take care of your trades.
Another thing that happens in a highly volatile market is emotional turbulence. Yes, especially new traders get emotionally attached to their trades, and this leads to havoc losses, and eventually, they lose interest in the market. Stop-loss can prevent this by closing all the positions when the price reaches the maximum loss the trader can bear.
Stop-loss orders have no extra charges attached to them as well. You can use them whenever you want and, if required, for all your trades.
Final thoughts
Everyone has the capacity to bear losses, and the losses can magnify in a highly volatile market situation. However, just by putting a stop-loss along with your trading order, you can reduce the probability or extent of your losses and survive in the market for a long.