Last week we posted the investors guide to stop loss orders which was a good introduction to not only what stop loss orders are but examples of how they work and reasons to use them. This post will take last week's post a step further with tips to use them successfully.
First, what are stop loss orders? Stop loss orders work like insurance so that in case the trade goes bad for whatever reason the investor will have his or her position automatically sold for a loss. There are two types of these orders: stop market orders and stop limit orders.
To make the most of stop loss orders, apply some of these tips:
- Never use stop loss orders for active trading. For investors that watch their screens all day and are involved in day trading a stop loss order serves little purpose.
- Watch for hidden fees. Different stock brokers charge different rates for these orders. A flat-fee structure is probably the best route to using stop loss orders.
- Never assume a stop loss order has been filled successfully. Always double check the trade confirmations page to confirm the order was filled in its entirety.
- For the original placement always give the stock atleast 5% of space to avoid market maker abuse. If the stock is trading at $100, a stop loss should be no higher than $95 initially as intraday price swings may cause the order to trigger prematurely.
- Don't use stop loss orders for large positions. For investors purchasing blocks of shares stop loss orders may hurt more than they help due to inefficient order filling.
- New investors should use only stop market orders. Stop market orders once triggered will simply sell at the current market price. Stop limit orders are advanced and are more prone to failure for filling in their entirety.
- Use stop loss orders to setup a profit vs loss ratio. Profits vs Loss ratios are a key tool for the highly successful investor and stop loss orders can help keep the discipline portion of the strategy intact.
- Keep an eye out for after hours trading gaps. Stock price gaps after-hours can cause the stock to trade through the stop loss order trigger price causing the order to miss altogether. This is can spell bad news for any investor's position (further reading: stock gap breakouts).
- Set the trigger price at common price increments. Prices like $100 or $60.50 are far more common to be traded at than $123.47. By placing the trigger price at a common increment there is a smaller chance of the stock "trading through" the order trigger.
- Use with stocks that have high average daily volume. Liquidity is important to help ensure the trigger price is hit (see tip #9). If the average daily volume is less than 100,000 shares for example than there is a higher risk of the order to be "traded through".
While stop loss orders can be easy to use, the above tips should help investors make the most of these order placements. Trade wisely.