January 11, 2016 at 10:50 pm #545m. deanParticipant
Stop loss orders, also referred to as a type of “hard” stop and placed with your broker, are generally defined as a way to limit a trader’s downside risk to an underlying security should the price fall to a determined percentage below their entry price. If in a long position, stop-loss orders effectively put the stock up for sale as a SELL stop-loss order as soon as price reaches that defined price. However, a stop-loss order can also be used in a short position, triggering if price trades above a defined price as a BUY stop-loss order.
See the chart below to see how a stop-loss order is triggered;
A word of caution, however, when using stop-loss orders execution is not guaranteed, especially in situations where trading in the stock is halted or if the security gaps down (or up if in a short position).
It is important to check with your broker to see if they allow placing stop-loss orders when trading penny stocks, as most brokers will not allow them on stocks trading in the OTCBB market. Many brokers do, however, allow the use of stop-loss orders when trading penny stocks that trade on the NASDAQ and AMEX exchanges.
When hard stop-loss orders are not available traders should consider using a “mental”, or soft stop, where they have a level in mind where he or she will exit a position if and when price reaches it. Usually this is placed just under or over a predetermined support or resistance area. A stop-loss order, whether hard or soft, does not have to be set below (or above if short) the stock’s purchase price. It can also be placed at a price level somewhere above/below the entry price to lock in some profit (ie: to cover commission costs), to trail price in hope of “catching a runner”, or placed at break-even.
Because trading penny stocks sometimes involves having to withstand huge price swings, stop loss orders can be hit, taking you out of the position then reversing and continuing in your desired direction without you. Thus many traders only use stop-loss orders when trading high volume, low volatility stocks. It is important for each trader to know his or her own risk tolerance, especially when trading high volatility stocks, as many penny stocks are.
Successful stock market traders and investors realize they can not control the reward. They can only control, and limit, their risk.
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