What is a stop-loss order?

A stop-loss order helps limit potential losses by triggering an order when a security reaches a specified price. Once activated, it may become a market order and execute at the next available price.

Key points:

• Investors select the stop price while placing the order.
• The order remains inactive until the trigger price is reached.
• A sell stop-loss is generally placed below the current market price.
• A buy stop-loss is generally placed above the current market price.
• Fixed stop-loss orders remain at the selected level.
• Trailing stop-loss orders adjust when prices move favourably.
• Execution at the exact stop price is not guaranteed.
• Price gaps and market volatility can increase losses.
• Stop-loss levels should reflect risk tolerance and market conditions.
• The order should be used alongside a broader risk-management strategy.

A stop-loss order is placed with a broker using a predefined trigger price. The order remains pending until the market price of the security reaches that level.

A sell stop-loss order is generally used when an investor already owns a security. The trigger price is usually set below the prevailing market price to limit losses if the security declines.

A buy stop-loss order may be used to manage the risk of a short position. In this case, the trigger price is generally placed above the current market price.

Once the trigger price is reached, a stop-loss market order becomes a market order. It is then executed at the most suitable price available in the market.

The execution price may differ from the trigger price. This can happen when prices move quickly or when there are not enough buyers or sellers at the selected level.

For example, suppose an investor purchases 500 shares of Company X at ₹10 per share.

If the share price reaches ₹8, the stop-loss order is activated. If the order is executed near ₹8, the investor’s approximate loss would be ₹2 per share, excluding applicable taxes and charges.

However, the order may execute below ₹8 if the price falls rapidly. For instance, if the share closes above ₹8 and opens the next day at ₹7.50, the order may be executed near ₹7.50.

This difference between the expected price and execution price is commonly called slippage. It is more likely during volatile markets, major announcements or periods of limited liquidity.

The securities quoted are for example purposes only and not a recommendation.

There are two commonly used types of stop-loss orders: trailing stop-loss orders and fixed stop-loss orders. Both aim to manage risk, but their trigger prices behave differently.

The choice depends on the investor’s objectives, risk tolerance and trading strategy. A trailing order may suit a position that is moving favourably, while a fixed order provides a clearly defined exit point.

Neither order guarantees that the security will be bought or sold at the exact trigger price. The market price available after activation determines the final execution price.

How does a trailing stop-loss order work?

A trailing stop-loss order protects potential gains while limiting losses. Instead of remaining at a fixed level, it follows the market price when the security moves in a favourable direction.

The trailing distance may be defined as a percentage or a fixed amount. As the security price rises, the stop-loss level also moves higher.

Suppose an investor purchases a share at ₹100 and places a trailing stop-loss order 10% below the market price.

If the price rises to ₹120, the stop level moves to ₹108. If the share later declines, the stop level generally remains at ₹108 rather than moving down with the falling price.

This allows the investor to stay invested while the price rises. It may also protect part of the unrealised gain if the price reverses.

However, setting the trailing distance too close to the market price may cause the order to activate during normal short-term fluctuations. Setting it too far away may expose the investor to a larger decline.

Investors should consider the security’s price volatility and their maximum acceptable loss before selecting the trailing distance.

How does a fixed stop-loss order work?

A fixed stop-loss order is placed at a specific price and does not adjust automatically. It remains at that level until it is triggered, cancelled, modified or expires.

Suppose an investor purchases a share at ₹200 and places a fixed stop-loss order at ₹180. The order activates if the market price reaches the selected trigger level.

Even if the share price later increases to ₹250, the stop-loss level remains at ₹180 unless the investor manually changes it.

Fixed stop-loss orders may also be linked to a particular investment period. An investor may decide to exit if the security does not perform as expected within the selected timeframe.

However, a stop level should not be based only on the amount an investor is willing to lose. Market volatility, liquidity, support levels and the purpose of the investment may also affect the decision.

A stop placed too close to the current market price may be triggered by an ordinary price movement. A stop placed too far away may allow a larger loss before the order is activated.

A stop-loss order helps investors manage downside risk by activating an order at a predetermined price. Fixed orders maintain one trigger level, while trailing orders adjust with favourable price movements. However, neither type guarantees execution at the selected price. Investors should consider volatility, liquidity, price gaps and their risk tolerance before placing an order. A stop-loss should form part of a broader investment plan rather than being used as the only risk-control measure.