Stop-loss order is used as a tool to limit the maximum loss on a position. In a stop-loss order two prices are to be entered, one is the Trigger price and the other is Limit Price.
Let us take couple of examples to understand the concept of Stop-loss order.
Stop loss – Buy Order
‘A’ short sells ACC shares at 1300 in expectation that the price will fall. However, in the event the price rises above his buy price ‘A’ would like to limit his losses. ‘A’ may place a stop-loss buy order specifying a Trigger price of 1325 and a limit price of 1330. The trigger price (TP) has to be between the last traded price and the buy limit price. Once the market price of ACC breaches the TP i.e. 1325 the order gets converted to a limit buy order at 1330.
Stop loss – Sell Order
‘A’ buys ACC at 1290 in expectation that the price will rise. However, in the event the price falls, ‘A’ would like to limit his losses. ‘A’ may place a stop-loss sell order specifying a trigger price of 1270 and a limit price of 1265. The trigger price has to be between the limit price and the last traded price at the time of placing this order. Once the last traded price touches or crosses 1270, the order gets converted into a limit sell order at 1265.
Important: Please note that in a buy order the Trigger Price (TP) cannot be less than the last traded price. This is treated as a normal order because the condition that the last traded price should exceed the trigger price for a buy order is already satisfied. Similarly, in case of a TP sell order the TP should not be greater than the last traded price for the same reason.
Thus a stop-loss order gets activated only when the Last traded price (LTP) of the Share is reached or crosses a threshold price called as the trigger price till that time the order will remain passive in the market. Once the last traded price of the stock reaches or surpasses the TP, the order becomes activated (i.e. eligible for execution by being taken up in the matching process of the exchange) and then on behaves like a normal limit order.
Precaution: Let the price range between the Limit price and the Trigger price be enough wide, otherwise in a volatile market your stop loss order may not get executed
Please refer to the following Demo video for Stop- loss order