Stop Loss Orders are very important for a trader to be successful and to preserve his capital. It is easy to buy a stock but when to exit is more difficult. It is human tendency to look for more profits and less losses. That is why when a trade is going against, instead of getting out of the trade, many traders sit tight and wait for the market trend to reverse. This never happens and in most of the cases the entire capital is lost. In order to limit your losses it is necessary to have stop loss orders in place. You should have a trading plan. This plan should include how you are going to trade, what is your stop loss levels and when to exit from profitable trade, etc.

What is a Stop Loss order?
A stop loss order is an order to buy (or sell) a security once the price of the security has climbed above (or dropped below) a specified stop price. When the specified stop price is reached, the order gets automatically executed as a market order.

Once the stop price is reached, the stop order becomes a market order. In a fast-moving market, or if there is insufficient liquidity available at the stop price, the price at which the trade is executed may be much different from the stop price. The use of stop orders is much more frequent for stocks, and futures, that trade on an exchange than in the over-the-counter (OTC) market.

An example:

Let us say you have decided to execute the following trade:

Buy Shares of BHEL at 2450.
Once the order is executed you will place a stop loss order as per your trading plan.
As per your plan if the price falls by more than 5% you will sell the stocks of BHEL. This is the maximum loss you will take for a trade that goes against your expectation. To know more on fixing the stop loss levels click here. Your stop loss price will be 2327.50. You will place an order for selling the stock if the price of the stock touches 2327.50.

The other scenario will be when you Sell Shares of BHEL – selling short – at 2450.
Once the order is executed you will place a stop loss order as per your trading plan.
As per your plan if the price rises by more than 5% you will buy the stocks of BHEL and square up. The maximum loss you will take for a trade that goes against your expectation. Your stop loss price will be 2572.50. You will place an order for buying the stock if the price of the stock touches 2572.50.

Market behaviour in unpredicatable. The price movements depend on events and developments that take place. Human tendency is you hate to lose more than you like to win. This fear of regret makes you to hold on to losers too long and sell winners too early. Investors tend to hold on to losing investments hoping that they will come back, rather than taking advantage of tax breaks. The contrary is true with winning stocks. Fearing a downturn and wanting to lock in profits, investors will sell stocks or funds too early and miss out on future gains. The solution to this emotional behaviour is to have proper stop loss plans in place and work unemotionally while trading.