A stop order is an instruction to buy or sell a stock whenever the
stock trades at or past a specified price, when it then becomes a
market order. You can use a stop order to protect existing profits or
reduce losses. Although a stop order might appear similar to a limit
order, they have some differences.
A stop order differs from a limit order in that after the stock’s
price reaches the stop-order price, the stop order becomes a market
order. Suppose that you buy some stock at $20 per share that is
now trading at $30 per share. Selling those shares would result in a
$10 per share profit. To protect this profit from a rapid price drop,
you can place a stop order to sell at $28 per share. If the stock drops
to $28, the stop order then becomes a market order and is executed
at the prevailing market price. If the stock is sold at $27.75 per
share, you have protected a profit of $7.75 per share. On the other
hand, if the stock keeps increasing from $30 per share after the stop
order is placed, the stop order lies dormant (if it has no time limit
and is a GTC order) until the share price falls to $28.
Similarly, you can protect profits on a short sale by using a
stop order to buy.
In addition to protecting profits, stop orders can be used to
reduce or prevent losses. Suppose that you buy a stock at $10 in
anticipation of a price increase. Soon after your purchase, news
from the company suggests that the price may go down rapidly.
You can place a stop order to sell at $9, which limits your loss if the
stock price declines below $9 per share. Limiting losses on a short
sale is the other use for stop orders.
Another danger awaits when you are setting a stop-order
price. If you place the stop-order price too close to the current price,
a temporary surge or fall in price of the stock can trigger execution
of a market order. Then, although the stock price might move back
in the direction you anticipate, you no longer have a position in
that stock. On the other hand, if the stop-order price is set further
away from the current market price, less profit is protected (or you
risk a greater loss).
Of course, the use of stop orders does not increase profits if
you do not correctly anticipate the direction of the market price.
Categories in Trading Mistakes
Lack of Trading Plan
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Using too much Leverage
Determining the proper capital requirements for trading is a difficult task
Failure to control Risk
Refusing to employ effective risk control measures can ensure your long-term failure
Lack of Discipline
A lack of discipline can destroy even the most talented and best prepared trader
Useful Advices to Beginning Trader
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All about Stocks
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