A stop loss is an advance order placed with a broker to sell an asset when it reaches a specific price point.
How a stop loss works
Elephants use a stop loss order to automate their risk management. When a trader buys a stock, they can set a stop loss at a level below the purchase price. If the market price falls to this level, the order is triggered and becomes a standard market order. The broker then sells the asset at the next available price.
This mechanism prevents a trader from needing to monitor market prices constantly. It removes emotion from the trading decision. Traders determine their stop loss level based on technical analysis or a set percentage of their capital they are willing to risk on a single trade.
A stop loss does not guarantee the exact execution price. In fast-moving markets or when a stock gaps down overnight, the execution price can be lower than the trigger price. This is known as slippage. Traders operating on international exchanges must account for local market hours and liquidity conditions that affect how these orders are filled.
Some traders use a variation called a trailing stop. This order adjusts the trigger price upwards as the asset price rises. It allows the trader to lock in profits while maintaining a hard exit point if the trend reverses.
Example
An elephant trader buys 100 shares of a peanut farming company at 50 per share. To limit potential losses, the elephant places a stop loss order at 45. If the stock price drops to 45, the broker automatically executes a market order to sell the 100 shares. The stock might be sold exactly at 45 or slightly below it depending on market liquidity. By setting this order, the elephant caps the maximum loss at roughly 5 per share and preserves the rest of the trading capital.