Capital Loss & Stop loss limits
Stop loss limits act as a safety valve in case something starts to go wrong. Stop loss limits state that specified action must take place if the loss exceeds a threshold amount. Tight stop loss limits reduce the maximum possible loss and therefore reduce the capital required for the business. However, if the limits are too tight they reduce the trader’s ability to make a profit.
The first step in setting stop loss limits is to determine the appetite of the company regarding its risk tolerance. This translates to specifying the amount of capital that the company can afford to lose.
The following elements would need to be considered when determining the capital loss amount.
- The expected rate of return that will be earned on the capital will the next twelve month period.
- The rate of return that will be required to satisfy shareholders.