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Chanakyaneeti Quantified

Understanding the Limitations of Stop Loss

Many learned analysts suggest Stop Loss as a tool to limit your losses. Let’s do a reality check for positions carried forward to the next day. As you would know, Stop Loss orders get cancelled at the end of the day, and fresh orders have to be placed for the next day. Let’s assume that a trader was having 1 Lot (1200 shares) of Open Position of Infosys Futures at the end of trading day of October 18, 2019. Infosys Closed at 760 on Friday, October 18th, 2019. He would have paid a margin close to around 2.5 lacs. Market opened on Tuesday, October 22nd, and opening price of Infosys was 684. But that was the highest price with razor thin volumes, and stock fell further. It made a low of 633.05 on that day, and closed at 634.

Following is the reality check:

  1. If you had put a fresh Stop Loss order for October 22nd for less than 10 % Loss, it wouldn’t have triggered (not executed). So, the minimum loss of 10%, i.e. Rs 76 (Closing 760-684 Opening) of the Trader would have been 1200 x 76= Rs 91200, i.e. 36.48% of his invested capital.
  2. Even for fresh Stop Loss orders of more than 10% loss, only those Stop Loss orders get executed which match with the Buy Orders at a given price, and which are placed earlier in priority. With most of big traders and institutions using sophisticated Software, it becomes a lost game for small traders. Thus, Stop Loss for many orders above 10% loss may not have triggered, and they would have automatically converted into Limit Orders.
  3. Brokers place automated Market orders if Loss of their clients exceeds a certain limit. So, if the small trader had not deposited more money with the Broker in time, his position would have automatically squared off at Market Rate. This also is one of the the reasons for Straight Line falls or Stock Crashes.

So, as clear from the above argument, Stop Loss may be a good theoretical concept, but reality is different, especially for those who carry their trades overnight. Even in the day Stop Loss Orders, with Software changing the Buy or Sell orders in a flash, your Stop Loss May not get triggered, even if it falls or rises above your Stop Loss Price. If sufficient Counter Orders are not there in the system, your Stop Loss order may get converted into Limit Order, thus depriving you of the chance to limit your Loss. The solution is to place Stop Loss Trigger Price in a wider range so that there is a sufficient probability of your Stop loss order being executed. There are many more angles to Stop Loss, and I'll discuss then in my future posts. 

© Kujnish Vashisht, Expedient Consultants, 91-9779883347, expedient33@gmail.com.

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