No one starts investing in the stock market with the intention of losing money. Although we get into investing with the intention of growing our money for the future, it’s important to realize that losing money is part of investing. In fact, it’s normal for the values of stocks to fluctuate. So, how do you deal with these fluctuations wisely? This is where tools like stop loss orders can come in.
Risk management
If you’ve begun reading up on our investment tips for beginners, you’ve probably come across terms like “emotional trading”, “portfolio diversification”, and “risk management”. But how do you translate these confusing terms into a practical investment strategy?
Especially in today’s volatile market with the uncertainty provoked by the trade war and other factors, it can be tempting to sell your stocks when you see a stomach-churning drop. You may believe that you are avoiding a bigger loss down the line.
Read also: What COVID-19 can teach us about systematic risk
However, making emotional decisions when investing is a sure-fire way to lose money and to distract yourself from long-term goals. But it is also true that some stocks don’t bounce back after losses. So, how do you manage this tension?
Risk management refers to the actions taken to assess and mitigate the inherent risks of investment. A key part of risk management involves deciding how much of your initial investment or profits you are comfortable losing. This is where stop loss orders come in handy.
What are stop loss orders?
Depending on how you manage your investments-through a financial professional, an investment app like FlexInvest, your own brokerage page-exactly how you implement a stop loss order may differ. However, despite the logistical differences, the concept is generally the same.
Think of a stop loss order like the gutter guards set up at the bowling alley for kids (or ungifted bowlers). Gutter guards help your bowling ball stay on track and prevent it from plunging into the trenches on either side of the lane. This, in turn, can prevent you from scoring a soul-crushing perfect zero.
In investing, a stop loss order can similarly keep your investment goals on track. A stop loss order is a predefined limit that you set to prevent loss beyond the level you’re comfortable with. While a stop loss order can’t guarantee you zero losses as gutter guards can, they can often prevent devastating losses.
A stop loss order can be implemented to prevent you from losing money on your initial investment or on a profit. As such, this allows you to control how much risk you are willing to embrace in your investments.
For example, if you want to avoid losing money on a particular investment, you can set an order to sell the investment the moment the price dips below a determined price – let’s say 15% below the price you originally bought it for. This tool allows you to determine the maximum amount of money you’re willing to lose.
It’s not always a good idea to sell your investments the moment you notice a downward fluctuation in the market. By the same token, it’s also not recommended to close your eyes and ignore downward trends in your investments. Stop loss orders can help you get more comfortable with long-term thinking regarding stock market investments.
Stop loss orders and long-term investing
Long-term thinking is key to becoming a smart investor for a number of reasons. Long-term investing can have tax benefits, can be built up gradually over time, and is generally more stable. While investors may experience dips and peaks over the short term, long-term investment often results in gains because long-term investments tend to yield greater returns despite short-term volatility.
Plus, a long-term orientation toward investing lets you build on the power of compound interest and grow your investments over time.
Even the best investors are not successful 100% of the time. However, stop loss orders are an excellent tool to help you manage your investment risks responsibly. For more information on risk management and the ins and outs of investment, check out the rest of the Academy library!
