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Day 67: Basic Stock Market Concept
What is the
“Risk-to-Reward Ratio” and Why It Matters with a Stop- Loss?
A risk-to-reward ratio compares how much you are
willing to lose on a trade (risk) versus how much you aim to gain (reward). For
example, if you buy at ₹100, set your stop-loss at ₹90 (risk ₹10), and aim to
exit at ₹120 (reward ₹20), your risk-to-reward is 1:2. Using a
stop-loss helps define your risk side upfront.
Tip: Always aim
for a reward that’s at least equal to or greater than your risk.
How Does Position
Sizing Relate to Your Stop-Loss Strategy?
Position sizing means deciding how many shares or
contracts you enter based on how much you’re willing to lose. Example: If your
stop-loss is ₹5 per share and you don’t want to risk more than ₹1,000, you buy
200 shares. This way you protect your capital even if the stop triggers.
Tip: Combine
stop-loss + position size = real risk control.
Volatility-Based
Stop-Loss Placement: What is it?
Instead of using a fixed percentage, a
volatility-based stop uses how much a stock typically moves (its volatility) to
place the stop. For example using the Average True Range (ATR) you might set a
stop at ATR × 2 below your entry.
Tip: In
high-volatility markets give your trade more “breathing room”.
Should You Adjust
Your Stop-Loss around News or Earnings Events?
Yes. During earnings announcements or major news
events, stocks can swing widely or gap. Many risk-management guides advise
widening the stop or reducing position size before such events because your
usual stop may trigger by regular noise.
Tip: Know the
event calendar and decide whether to reduce risk ahead of time.
Common Mistakes
Traders Make with Stop-Loss Orders?
Some common errors:
Setting the stop too tight, and getting
out of the trade because of normal fluctuation.
Moving the stop further away just to avoid
a loss — this increases risk.
Ignoring gap risk — when price
opens much worse than the stop level, you still lose more than expected.
𝗧𝗶𝗽: Set you stop loss
based on the market structure, not based on emotion.
Fixed Stop-Loss vs. Trailing Stop-Loss: What’s the Difference?
Fixed Stop-Loss: A set price
at which you will exit if the trade turns against you.
Trailing stop-loss: Moves up (for
a long trade) as the price rises, locking in profits while still allowing upside.
𝗧𝗶𝗽: Use trailing
stops for trending trades, fixed stops for such trades where you simply want
downside control.
Can Stop-Loss Orders Fully Protect You Against Gaps and Overnight Risk?
No. When a stock opens much lower than your
stop-loss trigger (a gap down), your stop may execute at a much worse price
(slippage). The stop-loss helps reduce risk, but does not guarantee
perfect exit price.
Tip: For trades
held overnight, consider wider stops, smaller size, or hedging.
How Often Should
You Review or Adjust Your Stop-Loss?
You should review your stop when market conditions
change — for example when volatility ramps up, or the technical support level
you used shifts. But you should not loosen your stop just to
avoid taking a loss — that defeats the purpose.
Tip: Review stops
only if the trade’s premise changes, not because you’re avoiding loss.
How Do Stop-Loss Orders Fit into a Larger Risk-Management System?
A stop-loss is just one tool. Good risk-management
also includes:
Position sizing
Proper risk-to-reward ratio
Diversification
Avoiding over-exposure in any single trade.
𝗧𝗶𝗽: Think of
stop-loss as your safety net, but you still need the full harness of rusk
tools.
Is Using a Stop-Loss Appropriate for Every Trader or Trade?
No — while stop-losses are useful, they may not
suit every strategy. For very long-term buy-and-hold investors, frequent
stop-loss use might knock you out of a strong business simply because of
short-term noise. For illiquid or highly volatile stocks, a standard stop might
trigger too early or at a bad price. The key is matching the stop-loss tool to
your strategy, time-horizon and risk-tolerance.
Tip: Use
stop-losses when they align with your strategy — not because “everyone uses
them”.
if you have any other questions in your mind relating to stock market basics or need any clarification, please put your query into the comment box, We will try our best to clarify the same
Disclaimer: The information provided on MoneyWiseMind is for educational and informational purposes only. It is not intended to be financial advice, and you should not rely on it as such. Before making any financial decisions, you should consult a licensed financial advisor.
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