Now, the stock has to be sold as soon as they reach the set price. In other words, the hard stop definition is the order from a brokerage firm that instructs the trader to sell the Underlying security if the Market price for the same drops below the assumed level.
It is also known as stop-loss as it helps you prevent a significant loss. The investor can decide the maximum price they can lose on the Underlying Security. Based on this, they can set a stop loss to minimize their risk. Once the hard stop is implemented in the security, the investor will not lose the amount higher than they can bear. Simply put, a hard stop can be defined as an investment strategy that keeps the investor from losing more than they can afford.
Whether it is a commodity or stock, the prices of the underlying security keep fluctuating on a regular Basis. The higher the fluctuations they experience, the more volatile the investment gets. In order to prevent the significant loss on their Portfolio holdings, the experienced and smart investors use stop-loss or hard stop technique. Let’s understand the concept with an example.
Suppose you have purchased 100 shares from a renowned company. Considering the nature of the shares, the prices of these stocks are highly likely to fluctuate. To control the risk, you implement a hard stop on these 100 shares. Basically, you will order the brokerage company to sell your shares if their price goes below $20 per share. Here, the $20 is the maximum you can lose. If the value of the shares falls below this assumed price, then the brokerage company will sell the shares to avoid further loss.
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Hard loss can help you save money you would otherwise lose on the underlying security if it experiences an unexpected decline. However, it can also result in a loss. As mentioned before, the stock’s value fluctuates all the time. You can never predict if the market price of the stock will recover or not. If you have implemented the stop loss on security, all your shares will be sold as soon as their market price reaches your assumed price level. Now, the value of these shares will either keep falling or it will recover. If the market price of the shares recovers after you have sold them, then you will suffer a loss.
Most investors use hard-stop with Technical Analysis. This helps them to increase their chances of success and prevent losses. By understanding the technical analysis and forecasting the possible future trends, an investor can avoid selling the stocks prematurely. That’s one of the reasons why some large investors do not even use the hard stop strategy. They wait for the recovery of the market price of the stock.