When the bottom falls out of your favorite stock’s price a stop loss order on file with your stockbroker can definitely help ease the pain.
A stop loss order instructs your stockbroker to sell when the price hits a certain point. The purpose of the stop loss is obvious -- you want to get out of the stock before it falls any farther.
A stop loss order works like this:
You tell your stockbroker you want a stop loss order at a certain price on the stock. When, and if, the stock hits that price, your stop loss order becomes a market order, which means your stockbroker sells the stock at the best market price available immediately.
Setting a Stop Loss
If your stock is trading at 40 per share and normally doesn’t fluctuate more than 1 - 2, then a stop loss order at 36.50 might be reasonable.
A fast-moving market may go past your target before your stockbroker can fill your order. The good news is you probably want out of a plunging stock at the best price you can get and will take what you can get.
Be careful where you set your stop loss points. If a stock normally fluctuates 3 - 5 points, you don’t want to set your stop loss too close to that range or it will sell the stock on a normal downswing.
Stop loss orders take the emotion out of a sell decision by setting a floor on the downside.
If you plan to be out of touch from the market, on vacation for instance, put stop loss orders in so you have some protection against an unexpected disaster.
Stop loss orders don’t guarantee against losses. When disaster strikes a stock, it may fall so fast the best you can hope for is to come out close to you price.
Stop loss orders are great insurance policies that cost you nothing and can save a fortune.
Unless you plan to hold a stock forever ...
You should consider using them to protect yourself.