Intraday trading involves doing the buy and sell of shares on the same trading day. While the fundamentals of the company drive the long term valuation of stocks, the short term price fluctuation of prices is driven by fear and greed of the traders. Day traders try to book profit by capitalizing on the price movements during the day. So, they keep a close eye on the price chart and apply different techniques to identify suitable instances to buy and sell the stocks.
However, the prices can fluctuate such that Invest in intraday trading at the right time to book profit or to avoid loss might not be possible. To ensure that the loss does not exceed a certain limit stop loss is used to limit the loss in a trade. Whether the trade is on the long side or short side, stop loss is an effective protection against volatile price movements during the day.
When you add stop loss to order, it ensures your trade gets executed at the stop-loss price when the market tends to cross the stop loss level. This effectively saves a trader from bearing heavy losses on the trade.
How to use stop loss
For the long trades, where a trader buys the stock and sells it later, the intention is to buy at a lower price and sell when the price rises. Since an intraday trader’s order gets squared off during the day, what if after he has bought the share, the price starts falling? By the time market closes, if the price has dropped significantly, he will bear a huge loss. However, had he placed a stop loss, the trade would have got executed if the price touched the stop-loss mark, thus restricting his losses.
Day traders generally use the charts to determine the support and resistance level of a particular stock. For a long trade, they tend to place an order at the support level. Historical analysis of stock price chart gives a level (support) from where the share price has bounced back. So, a stop loss has to be placed slightly below the support level.
For a short trade, where a trader sells the stock first, and they buy it later, the approach should be to place the sell order at the resistance level. Resistance is the level from where the stock price has historically touched a ceiling and then came down. So, a stop loss has to be placed slightly above the resistance level
Importance of stop loss
- Protection of capital: Any trader works with a limited amount of capital, and stop loss is an effective technique to protect the capital while trading
- Trading Discipline: Trading is about managing emotions and treading with discipline, not getting swayed by market volatilities. Stop-loss brings discipline in stock trading by minimizing risks when the market continues to be volatile.
- Helps reduce margin requirements: Margin requirements can be reduced by placing orders with stop loss, since it implies a disciplined trader managing risks appropriately.
Hence, stop loss is of great aid for traders and must be used effectively before placing the order itself from their online trading account. It will not just help protect capital, but also help become a disciplined trader.
Getting started with intraday trading
If you haven’t started trading yet, it’s a good idea to open a demat and trading account and start trading in share market. Demat and Trading account is a prerequisite to trade and it can be opened quickly in less than 10-15 minutes.