What does price target and stop loss mean in stock market?
In stock market price targets and stop loss targets are two really important terms. So, when trading in Share market you must not only be aware of these terms, but use them in your trades to keep loses minimum and earn maximum profits.
What are price-targets?
A price target can be defined as the expectation of the analyst for the future price of a stock. The price target of a stock is the price at which the stock is rightly valued in relation to its previous and expected earnings. By buying and selling stocks that are trading below and above their price targets, investors can increase their rates of return. Research analysts usually publish stock price targets along with buy and sell recommendations.
Methodology
Start by determining the fair value of a stock. This includes estimating future earnings potential by studying historical results, competitive environment and the economic conditions. The price target of a stock can be a multiple of the price-to-earnings ratio, which is the market price divided by the previous 12-month earnings. This multiple could be the industry multiple, the company’s earnings growth rate or a combination. Say, annual earnings growth rate of a company is 10 percent and the stock is currently trading at $20, then a possible one-year price target could be 1.10 multiplied by $20 or $22. Similarly, if the industry price-to-earnings multiple is 18 and the company expects to earn $1.10 over the next 12 month, then another possible price target would be multiplied by $1.10 or $19.80.
How it works?
Say, your investment bank provides research reports about AMC company’s stocks. The analyst studies the industry, ABC company’s competitors, its products, management etc. The analyst prepares a financial forecast for ABC company and decide, based on that forecast, that AMC company stock is worth as much as $10 per share right now, even though it is trading at $6 per share. The analyst thus sets a $10 price target for the stock, meaning that analyst expects shares of ABC company to rise to $10 in the near future.
Why it is important?
Price targets not only provide insights to investors but it also provides instruction about when to buy and sell. In addition, price targets can also provide indications about when most other investors are going to buy and sell, which proves to be potentially lucrative trading strategy.
What is stop-loss order?
A stop loss is an order to buy or sell a security once the price of the stock rises above or drops below a particular stop price. When the specified stop price is reached, the stop order is entered as a market order or a limit order.
With a stop order, the trader doesn’t have to constantly track the performance of the stock. However, because the order is automatically triggered when the stop price is reached, the stop price could be activated by a short-term fluctuation in a stock’s price. When the stop price is reached, the stop order becomes a limit order or a market order.
Types of stop loss order
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Stop loss limit order
A stop loss limit order is an order to sell a stock at no less (or buy at no more) than a specified limit price. With this trader get some control over the price at which the trade is executed, but may prevent the execution of the order.
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Stop loss market order
It is an order to sell (or buy) a stock once the price of the stock drop below (or climb above) a specified stop price. On reaching the specified stop price, the stop order is entered as a market order. In other words a stop loss market order is an order to buy or sell a stock at the current market price prevailing at the time the stop order is initiated. This type of stop loss order gives the trader no control over the cost at which the trade is executed.
Pros and cons of the stop loss market order
The key benefit of a stop loss market order is that the stop loss order will always be executed. The key disadvantage is that the trader has no control over the price of the execution of the transaction.
A stop loss order is an easy tool, still a number of investors fail to use it. Whether to lock in profits or to prevent excessive losses almost all investing styles can benefit from this trade.You can think about stop loss as in insurance policy, you hope that you never have to use it, but it is good to know that you are protected in case you need it.
So, when trading in stock market, use price-targets and stop-loss targets to reap maximum benefits.