The basic concept is to protect an investor once he or she has made an investment.a stop loss protects an investor when he or she purchases stock. for example, letssay you are interested in buying xyz inc. at $10 a share. you noticed a chart patternthat suggests a probability of higher prices, but at the same time you know that thestock shouldnt drop more than a dollar based on your research. so you enter a stoploss at$9. you can now go mind your own affairs without having to worry about monitoringthe stock much. if the stock drops to your stop loss price, an order is executed to sellyour shares at a small loss.many investors do not use stop loss orders. the feeling is that the investor can get outof the market when the time is needed. unfortunately, a lot of emotions can get in theway of making a sound decision when the stock starts to drop and you are losingmoney. its not uncommon for someone without a stop loss, for example, to watch thestock drop to $9, know that they should get out, but continue to hold the stock hopingto recover some of the money lost. in the mean time, the stock then drops to $8. sonow the investor is really worried, but holds on in the hopes of gaining back some ofwhat was lost. in the mean time, the stock drops to $7. now the investor has lost 30%of the investment, panics, and sells. entering a stop loss order could have saved a lotof time, stress and money. stop loss orders are not perfect, of course, but can be abenefit to your trading performance.stop loss orders are also used to lock in profits. for example, the stock you bought at$10 jumps to $15. so you cancel your $9 stop loss order and enter a new stop loss for$13.50. again, you can mind your own affairs and take your eye off the stock, knowingthat if a big turn around occurs, your stop loss will get you out of the market and protectsome of the profit you have made.a stop buy works in reverse to a stop loss order. for the investor who have sold shortat $15, for example, he or she can enter a stop buy order at $16. the investor ishoping the price of the stock will drop, but is protected from an adverse move. if theprice of the stock rises to $16, a market order is entered to close the transaction. thisprotects the investor from more serious losses.just like a trailing stop loss order that follows the market higher to lock in profits, youcan also use a trailing stop buy order to follow the market lower to lock in profits on ashort sale.
