Stop Loss Orders: How to Buy and Sell Shares – Part III
Two weeks ago I gave you a primer on buying shares.
And last week I gave you the inside run on selling shares.
[Ed Note: You can now download the entire ‘How to Buy and Sell Shares’ six-part series for FREE. To download your copy right now go here.]
But that’s not all. Last week I also wrote this:
“I’ve received a number of related questions which I’ll cover next week in a Q&A session. So, if there’s anything you feel I haven’t covered and you have any questions, just send them to email@example.com and type ‘Questions about buying and selling shares’ in the subject line.”
So far I’ve collected over five pages of questions! At this rate the series could end up going longer than Neighbours!
Fortunately, some of the questions were similar. The most popular was to do with stop-loss orders. So that’s what I’ll cover this week.
But to give you a taste of the things I’ll cover over the next few weeks, here’s an edited list:
- What are exchange traded funds (ETFs) and how can I trade them?
- You say to buy gold and silver, but isn’t that for rich folks?
- I’ve heard about CFDs. What are they and should I use them?
- Do I have to tell the tax man about any profits I make from shares?
- Should I be a trader or an investor?
- How much do I need to get started in shares?
- How does the stock market work?
- Are call options and put options just for the experts or can anyone use them?
- I’m interested in short-selling but I don’t understand it.
- I’m having sleepless nights worrying about my shares, is that normal?
That just about covers it. Now, some of those subjects overlap. So, in coming weeks I may combine some of those questions and answers in the same topic.
But I can’t tell you in which order I’ll answer these questions, because… well, I haven’t written the answers yet. So you’ll just have to read each weekend to find out. Until then let’s take a look at this week’s topic…
Stop Loss Orders
Some of our investment advisories recommend using stop orders. The instructions for using stop orders may look like this in the investment advisories:
“Action to take: Buy XYZ Limited [ASX: XYZ], recent price 20 cents. Buy up to 25 cents and set trailing stop at 16 cents”
The part we’ll focus on this week is the last part of the instruction – “…set trailing stop at 16 cents”.
So, what is a stop-loss order? The best way to think of it is a stop loss helps stop you losing money. Or, if you’re in profit, it helps stop you giving back your profits if the share price falls.
Here’s how it works: say you get a share tip from me to buy XYZ Limited stock at 20 cents. You like my reasoning and so you buy it.
Now, here comes the stop loss part. The idea of a stop-loss order is to protect you if the share price falls. In this instance, let’s say I tell you to set your stop-loss order at 16 cents. That means you sell the shares if the share price falls to 16 cents.
This protects you, because if the stock keeps falling – to 15, 14, 12, or 9 cents – you’ll still only lose 4 cents per trade, so long as your stop loss is in place.
It’s as simple as that. As for the “trailing” part of trailing-stop orders, it simply means if the share price keeps moving up, then you should keep moving your stop order higher.
So let’s say that within a week the share price has moved from 20 cents to 30 cents. If you want to make sure you don’t give back the 10 cents of profits, you could move your stop order from 16 cents to – say – 25 cents.
This means if the share price falls, you’ll sell the shares for 25 cents, giving you a 5 cent profit. Simple isn’t it? Well, almost…
Unfortunately, some online brokers have different ways of handling trailing-stop orders. In fact, they can’t even agree on what to call them.
In some instances you’ll find them called stop orders. In others it could be conditional orders. And others may call them trigger orders.
If you’re unsure whether you’re using the correct order for your trades always give your broker a call to clarify it with them. Maybe even get them to walk you through a trade while they’re on the phone.
But, there is an alternative. Some traders and investors don’t use actual stop orders. Instead they’ll set up an alert with their broker. This means they receive an email or an SMS when a share price reaches a certain level.
So for instance, you may want to get an alert if the share price falls to 17 cents. In that case, once you’ve received the alert you can then decide whether you’re happy to hold on or whether you’d prefer to sell.
This works well for many people. And it’s certainly a good alternative if your broker doesn’t offer stop orders.
Oh, and by the way, even if they offer stop orders, some brokers will charge you just for placing the order. And when you sell the shares, they’ll charge brokerage too!
So make sure you check out all the costs with your broker.
Now, there is one final thing to point out. Setting a stop order DOES NOT guarantee that you’ll sell the shares at that price.
Which Stop Order?
There are two types of stop order, so you should ask your broker which one they offer. The first type is just a plain old stop-loss order.
If the share price falls to 16 cents it will trigger the stop-loss order and sell your shares as a market order. That means you’ll sell the shares at the highest price on the bid side of the market (refer to last week’s article).
If the highest price on the bid side is 16 cents then that’s the price you’ll get. However, in a fast moving market it’s possible that by the time your order is processed the highest price on the bid may only be 15.5 cents or 15 cents. In that case, this is the price you’d get.
That’s “gapping”. Where a price “gaps” through a price level.
The alternative is an order type called a stop-limit order. This is slightly more complicated. It works like this…
When you set your stop level, you also set a stop-limit level. It could be something like this: you set the stop level at 16 cents and the stop limit at 15 cents. So, when the share price hits 16 cents an order will go into the market to sell your shares, but at a price no worse than 15 cents.
That means you won’t sell the shares if the price “gaps” through 15 cents to 14.5 cents and then 14 cents. You would still hold them. In contrast, with a standard stop-loss order your shares would have traded at 14.5 cents and you would have sold them.
Finally, there’s always the chance that after you sell the shares, the share price could rally and move higher again. That can be frustrating. But, if that happens, my advice is to quickly lick your wounds and move on.
Because, do you know what? For every time that happens there are other occasions when the share price keeps falling and you’ll wish you’d sold.
In my view stop orders are a handy tool to help minimise your risk. Plus it helps make sure you don’t give away all your profits if the share price starts to fall.
I hope that gives you some idea about how stop orders work. Of course, because I only have limited space, there may be a few points I’ve missed. But this is a good starting point for you, and should give you the confidence to speak to your broker about how they process stop orders.
Of course, if you’re a high-risk speculator then you probably won’t want to use stop orders. If that’s the case that’s fine. They aren’t compulsory. And they aren’t for everyone
But ultimately, it’s completely up to you.
Next week I’ll cover one or more of the questions listed above.
For Money Morning Australia
P.S. This is just one, of a six-part series written by Money Morning Publisher Kris Sayce. For your convenience we’ve bundled the whole series into a brand new report titled ‘A Beginner’s Guide to the Stock Market: How to Buy and Sell Shares’. In it you’ll find easy–to–read and jargon free instructions on the steps you need to take to jump into the market TODAY and buy and sell your first lot of shares.
If you’ve got an interest in the share market, but completely new to the whole deal and don’t know where to start… download Kris’ new report today and he’ll show you everything you need to know to get started. Go here to download your free report today.