Trading at the stock exchange involves many risks. That’s why investors have come up with different ways not to go broke. We tell you about two most popular ones.
There are different ways to make money in the stock market. The easiest option is long-term investments. The investor chooses shares of companies which he thinks will grow and buys them for a period of at least a year.
In this case, the risk of investment is low. Temporary drops in prices do not bother investors. Over a long period of time, prices tend to recover, and the shares somehow bring profit to the owner.
Short-term investments are much riskier. Investors make money on small fluctuations in stocks. This requires vigilance, especially in a volatile market. Otherwise, significant losses can be incurred.
It is possible to limit possible losses in the market. To do so, you must instruct your broker to sell the stock when a certain level is reached. Such stock orders (also called “orders” or “bids”) are called stop-losses and take-profits.
What is a stop loss
A stop-loss is an instruction for a broker to automatically sell a stock when the prices fall to a certain level. A kind of loss limiter.
For example, you bought a stock at $50 a piece, and it started to go down quickly. If you can’t afford to lose more than $7 on each share, you set a stop loss at $43 per share. When the quotes reach that level, the stock will automatically be sold. The investor determines in advance the price at which he or she will incur the maximum allowable loss and then reports it to the broker.
How Stop Losses Work
Stop-Loss protects the investor from too big losses. It is considered very dangerous to trade in the market without using a stop-loss.
Stop Loss is also useful if an investor has no time to sit in front of a trading terminal and monitor quotes dynamics all the time. It will also help limit losses in case of force majeure, such as a power outage or stock market malfunction.
Finally, a stop-loss will save you money if you misjudged the situation during trading. For example, if he thought that the downward price trend will end soon and the stock will recover its losses, but his expectations were not met, and the stock continues to fall.
The maximum effect of stop-losses occurs when an investor buys a stock based on short-term factors. In other words, he makes short-term speculations, rather than “plays long”.
If, on the other hand, stock purchases are made based on fundamental factors, then stop-losses can rather get in the way. Fundamental factors include macroeconomic data, operational indicators, industry trends, and others.
What is Take Profit
Take Profit literally means “to take profit”. If stop-loss limits the amount of loss, then take-profit limits the amount of profit. The investor defines the price at which the broker will automatically sell the stock when it rises.
At first glance, such profit limitation seems strange. But in some situations, taking profit saves the day. As a stop loss, this order helps if the investor has no time to monitor the stock price, waiting for it to rise higher.
In addition, a take-profit order can protect against force majeure, technical problems, and incorrect assessment of the market situation.