This is how you can limit losses with stop-loss orders

The fear of a second shutdown has slowed the upward trend on the stock marketsimago images / Kyodo News

The Dax, the S&P 500, the Nasdaq Composite – many stock indices have fallen in recent weeks. There was a noticeable downward trend, especially in technology stocks, whose prices had previously risen particularly sharply. Is the stock market party over now? Investment professionals are at odds: some view the setbacks as signs of an overdue normalization. They are convinced that things will continue to improve in the long term. Others, however, interpret the correction as a warning sign. They fear that the markets have overheated and a new stock market crash is imminent.

Falling prices are part of everyday life on the stock exchange, but are sometimes difficult to bear for investors. Many investors are likely to be traumatized by the crash in the spring, when share prices at the beginning of the Covid-19 pandemic fell faster and deeper than ever before. If you don’t want to go through another crash to the bitter end, you can place stop-loss orders.

How do stop-loss orders work?

Investors can use this instrument to protect their portfolio against losses, in other words, to hedge profits. You can give your broker a stop-loss order like a normal securities order or, as a customer of an online broker, instruct it yourself. A so-called stop price is set for a certain security. If its price falls below the specified threshold, it is automatically sold. Attention: the stop rate is not a guaranteed price. The sales order is implemented at the best possible rate – this can also be below the defined mark. If there is bad news after the end of trading, for example, the stop-loss order does not take effect until the next trading day. By then the price may have fallen well below the stop price.

Where should the stop course be set?

Below the current course, of course. How far below this depends on your personal risk tolerance. Before you decide how much minus is still okay, you should look at how much the price of the security in question fluctuates on average, and take this fluctuation range into account. Because if you set the stop price too tight, it can happen that the sell signal is triggered by an insignificant setback, but the price continues to rise in the long term. Setting the stop course requires a lot of thought and instinct.

Is there no rule of thumb?

Unfortunately not. One can orientate oneself on technical chart brands. Chart technicians say: If a security falls below a certain threshold, there is a high probability that its price will fall further. However, one should not give too much attention to such forecasts. Technical analysis, even if it comes across as serious, is not an exact science.

When should you readjust the stop course?

That depends on how much the price of the security rises. If it goes up steeply, you should definitely adjust the stop course. Otherwise, if the trend reverses, there is a risk of a deep fall with high losses. However, you shouldn’t readjust too often. Many banks and online brokers charge fees for every adjustment. Here too, a sure instinct is required.

What is a trailing stop order?

This is a stop-loss order that is automatically followed. If the price of the hedged security climbs, the stop price climbs with it. The desired sales mark can either be specified in relative values, for example: Sales at five percent below the current price. Or in absolute numbers, for example: Sale at a loss of 10 euros. In the same way one can determine when the trailing stop is raised.

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