A stop loss order is placed as an automatic ‘exit’ option from a loss trade. Stop loss orders are an integral part of short-term and intraday trading strategies and help take emotions out of play while taking ‘exit’ decisions.
A trader approaches a trade with a pre-determined loss tolerance limit and by setting up a stop-loss order (mentioning a trigger price), he automatically exits the trade once the tolerance limit (i.e the trigger price) is breached. A stop-loss order helps minimise losses in a market that is rapidly moving in a direction opposite to the one the trader is betting on.
Stop loss orders are of the following two types:
1. Stop Loss Market (SL-M):
In case of a SL-M order, once the trigger price is breached, a market order will be sent to the exchange and the order will be executed either at the trigger price or at the best available price. A stop loss market order will ensure a guaranteed execution; however, the execution may or may not be at the trigger price.
2. Stop Loss Limit (SL-L) Order:
In case of a SL-L order, one needs to input a ‘trigger price’ and a ‘limit price’.
For a SL-L Buy order, the trigger price cannot be greater than the limit price. Once the trigger price is reached, a buy order will be sent to the exchange. The shares will however not be bought at a price higher than the ‘limit’ price.
Similarly for a SL-L Sell order, the trigger price cannot be lower than the limit price. Once the ‘trigger price’ is breached, a limit order will be sent to the exchange. The sell in this case would not be executed at a price lower than the ‘limit’ price.
In case of a Stop Loss Limit Order, there is however no guaranteed execution as there may or may not be buyers/sellers available at the given price range.
Stop Loss Market Vs Stop Loss Limit Order – Which order to place?
In case of a stop-loss limit order, there is no guarantee that the order may be filled; as in a rapidly rising or falling market there may not be buyers/sellers available at the given price range. The stop loss order in such a case will remain pending while your capital gets eroded away.
A safer bet therefore is to place a stop loss market order that guarantees execution once the trigger is breached (even though the execution price may be lower/higher than the trigger price) and thus helps minimise your losses.