Stop Losses and Profit Stops - Two Extremely Powerful Weapons in Any Traders Arsenal

What is a stop loss? What is a profit stop?

Let's say that you buy 1000 shares of MSFT at $50 even. Well when you buy the stock, you can enter in a "stop loss" into your trading software. You can either enter a hard stop at $49, or a trailing stop loss of $1. What does this mean?

If you enter a hard stop loss at $49, it means that if the price of MSFT hits $49, then the trading software will exit your position automatically. It will do whatever it can to get your out of the position at $49 or anywhere close to it. This can be extremely handy if you want to protect your downside and you can't be in front of the computer during all hours of the stock market.

A trailing stop is a little more complicated. Let's say you buy MSFT and it immediately goes up to $52. If you put in a trailing stop loss of $1, that means that if the stock ever trades down $1 from its high, your trading software will immediately exit you from the stock. Trailing stops are great if you are in a stock that is in an uptrend but you aren't sure as to the perfect moment when to exit the stock. This is the perfect situation for a trailing profit stop.

The only downside to using stops is that market makers can see all of the stops that are in place on a stock. So, if there are 100 stop losses set at $100 on a stock, the market maker might be tempted to take the stock down to $100 in order to clear out all of the stop losses. The market maker will take all of your shares off of you at $100, and then the stock will move back up after the selling pressure is done. If you are going to set a hard stop, try to avoid an obvious number like $100 even. Instead go for $100.25 or something of that nature.

Stop losses and profit stops. A must-have tool for any serious trader or investor.

Filed under: Stock Market Education | General Knowledge