No image 5paisa Research Team 11th December 2022

How to use stop loss order as an effective intraday trading idea?

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One of the key weapons of intraday trading is the stop loss. What exactly is a stop loss? Stop loss is a protection to your trade (it can either be on the long side or short side). Stop loss is almost mandatory, irrespective of whether you are trading in stocks or indices like the Sensex/Nifty. Here is why! Markets, by default, are volatile and hard to predict and this risk gets more pronounced in intraday trading. That is because markets are driven by fundamentals in the long run but by greed and fear in the short run. That is why markets tend to react violently to news flows. A stop loss is your insurance against such movements.

How exactly should you place a stop loss?

The illustrative chart outlines where to place the stop loss; for long trades and for short trades. Let us look at the long side first. When you buy, your approach should be to buy around the support levels. These support levels are formed by prices historically bouncing from a particular level. In a long trade, you buy above the support level, but put your stop loss slightly below the support level. Let us now turn to the sell side.

When you sell, your approach must be to sell around the resistance levels. These resistance levels are formed by prices historically hitting a ceiling at a particular level. In a sell (short) trade, you sell below the resistance level, but put your stop loss slightly above the resistance level. The crux of the argument is that a stop loss is a necessity irrespective of whether you are trading on the long side or on the short side; more so in Intraday Trading.

Why stop loss is important for a trader…

Stop losses may be based on technical levels or based on the losses you can afford to take. Either ways, stop losses cannot be an afterthought but must be placed at the time of the order placement itself. Here is why stop losses are the key to the sustainability of a trader in the stock markets.

  • Be it a small trader or George Soros; every trader works with finite capital. The first objective of trading, therefore, is to protect your capital. That is done with the concept of stop losses.

  • Stop loss instill discipline in trading. Every trade is based on the concept of risk-return trade-off. That means; you set your likely return as a multiple of your likely risk. The likely risk, here, is defined by the stop loss.

  • Stop loss is your defence against market volatility. Any trader has to live with volatility in markets. Stop losses ensure that the market volatility does not throw any negative surprises at you.

  • Stop loss assists in churning of capital. As a trader your primary aim is to profitably rotate your capital and keep compounding returns. We often move to the category of investors when we decide to continue despite the prices moving against you. That is prevented by the stop loss discipline.

Stop losses can make your trades more economical

Stop losses are a must, this is because they instill intraday trading discipline and keep your risk in check.  But, these stop loses also make your trades a lot more economical. This is how it works. Normally, intraday trades are charged much lower brokerage and statutory charges like STT are also lower for intraday trades. But you can further reduce your margin requirement if you put stop losses at the time of placing the order. These are referred to as cover orders. You can also put a bracket order which imputes a stop loss and profit target at the time of order placement. Compared to normal intraday orders, cover orders and bracket orders attract still lower upfront margins. That works to the trader’s advantage.

The crux of the story is that if you are a trader you need to build the stop loss discipline into your trading. Whether you are trading stocks or indices like the Sensex/Nifty; intraday trading is all about leverage. Just as profits can multiply, losses can also magnify. That is where a stop loss fits in!

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