How Stop Losses, or Stop Loss Orders, Can Prevent You From Losing Money

Let’s explode a myth about buying shares. When you invest in shares you don’t have to take the risk of losing all of your money. There is a little device called a stop loss order, and you can use it to do exactly what it says, stop a loss.

Here’s how.

1.     Set Up A Stop Loss Order

A stop loss order is a facility set up with your stockbroker to sell a share once it has hit a target price, whatever that may be.

An example to illustrate the point.

Let’s say you bought shares in company A for £10. You are willing to risk no more than 10% of your money being lost on this investment.

Upon buying shares in company A for £10, you set up a stop loss order set at 10% below the price at which you bought the shares. In doing so, should the share price fall more than 10% below the purchase price it would trigger an automatic sale limiting your loss to a maximum of 10% of the original investment.

To put it another way, you could buy £1000 worth of shares and never have more than £100 actually ‘at risk’ in the above 10% example. Doesn’t seem quite so risky now does it?

2.     Consider Your Risk Parameters Carefully

Stop losses can be a great way to manage your exposure to risk and leave you worry free that you have set comfortable limits on how much money you can lose, but there is one slight limitation to stop loss orders that the investor should be aware of.

When setting the parameters of your stop loss order always consider the historical price volatility of the share in question and how volatile the stock market is behaving in general. If the stock is highly volatile with a wide share price deviation, your stop loss order is likely to be triggered very quickly.  This can cost the investor money in trading execution fees.

3.     It’s Simple.

The principle of a stop loss order is very simple indeed, yet many investors often do not use this facility. A stop loss order is really another way of creating a margin of safety in your investments by limiting how much you can lose. It’s a simple concept and simple to apply and works for just about any investment style whether you are a value investor, trader or something else.

Investors who consider themselves to be a little risk averse and who are concerned about losing all of their money when buying shares should consider stop loss orders as they provide a simple solution in providing protection against losing money.

Jamie E Smith is the author of Making Money From Stocks And Shares

This content was provided by one of our users, Jamie