What are stops and how should I use them?

Stops are one of the most important things that traders should know about, whether you are a small time investor, or a big time investor. Stops are one of the most important ways of protecting your investments and insuring that you don’t lose too much money.
Stop stands for the term stop-loss. Stop loss measures are a way to set a limit on how low your stocks can go before you sell them. A stop-loss order is a bottom line that you set when you buy a stock. When the stock reaches a particular place, or when it drops a certain percentage or amount, then it will automatically sell.

Essentially, a stop loss is built in discipline for both you and for the stock. But the only way that a stop loss will work is if you don’t ever, ever change the level that you set. You decide how much of a loss you are willing to take, and then place a stock loss so that when a stock starts to fall, then the stock will automatically sell.
You have to decide where you want to set your stop loss. Where you set your stop loss depends on what your investment strategy is. How much are you willing to lose? How much are you willing to risk? If you are an aggressive trader, then you might be setting your stop losses at a different level than if you are a conservative trader. Nobody can come up with a specific place where you should set your stop loss, but a general rule of thumb that you might want to consider following is to set it at 10 points, or maybe 20 % of your buying price. So if you buy a stock at $10 a share, when they fall 20% to $8 a share, then you will automatically sell the stock. You will be taking a 20% loss, which will hurt, but the benefit is that you won’t be taking any further loss on that stock. Deciding where to set your stock can be a really tricky and touchy thing to do. If you set your stop loss level too high, then you will end up essentially just liquidating your stock portfolio. If you set your stop loss level too low, then you end up losing a ton of money.
There are traditional stop losses, and there are also something called trailing stop losses. The trailing stop losses readjust themselves as the price of the stock increases. This means that as your price value increases, then the level of your stop loss, or the line on the stock chart that you will not let your stocks fall below will shift itself as the value of the stock increases. However, just like traditional stop losses, trailing stop losses have to be set before you actually initiate the trade. Don’t let the stop loss level change until the value of the stock moves above a certain level. Set your timing and the use of of your stop losses, trailing and traditional, before hand, because that will give you a level of discipline that is difficult to maintain and to set otherwise.
So what are the particular disadvantages of stop losses? Well, first of all, a stop loss might end up in an automatic sell even though the stock isn’t really plummeting. Stocks drop normally as a part of the general rise and flow of the stock market. A stop loss might automatically sell even though the stock will bounce up. If you set your stop loss in the wrong place, then you can end up negatively affecting your investments, since it doesn’t allow for natural corrections. The other possible problem with stop losses is that if a stock suddenly plummets, due to bad news, then the price will shoot right through your stop loss and the automatic sell will not kick in. So a stop loss is not necessarily a sure save that will prevent losses. But the benefit of a stop loss is that generally it can help you save money on your investments.