Using a stop loss virtually removes the human element from the emotional decision to sell a stock or cover a short sale. Youll stop yourself before you destroy your account. With most of your capital preserved, youll return to invest another day.

The stop loss is simply a sell order that is placed a point or two or three below your buy price when you enter a stock position. If the market goes against your stock and it declines to your stop price, a market order is automatically triggered to promptly take you out of the position. The theory is simple: Take a small loss today rather a big loss tomorrow.

We suggest using a stop loss for nearly every one of our plays. The placement of the stop can be quite specific, i.e., placing the stop just below the point where the stock breaks out of a strong chart pattern. Or it can be general, maybe a couple of points to give the shares some wiggle room during periods of market volatility. In most cases, well set a stop to limit our potential loss to no more than 10%.

But a stop is for more than downside protection. It should also be used to lock in profits when a trade is going your way. The technique is using a trailing stop.

Say you bought shares in XYZ at 20 and set your stop loss at 18. A week later XYZ is at 22. The savvy investor will cancel his old stop and place a new one at 20. If the stock sells off and hits 20, youll be out of the position at break-even. If XYZ continues to climb to, say, 24, you can put in a new stop at 22 and lock in a two-point (10%) gain. In a rising market, you might be able to trail the stop below an advancing stock for weeks or months, locking in additional profits along the way.

(Note: For short sales­which profit when the underlying stock falls--the stop loss rule applies in reverse. Set the stop loss a few points ABOVE the entry price and trail it downward as the shares decline.)

If you work with a traditional broker, he or she can set the stop loss when you make your purchase. Make sure the broker places a firm order in the system and doesnt use a mental stop like, Get me out if it hits 60. That unverifiable type of order got Martha Stewart into trouble.

If you use an online broker, you can set your stop and adjust it electronically with a few mouse clicks. Youll probably be asked to designate your stop as a day order that expires at the end of the trading session, or good til cancel, which keeps the order in place until you remove it. Most brokerages allow good til cancel orders to expire after 30 days, so it is important to monitor your account periodically to adjust your stops and make sure the orders are still active.

A version of the stop order is the stop limit order. In this case, a sale will occur only at the exact price you determine instead of at the market.

This protects the investor in case the stock gaps down at the open because of bad news, an earnings disappointment, etc. If you set a traditional stop at, say, 18, and the stock gaps down at the open to 16, a market order will be triggered and the order will likely fill around 16. If a stop limit is in place, however, there will not be a sale at 16 but only if the price drifts back to 18. This sort of gap-down and bounce-back happens regularly, and a stop limit can save a lot of money in these cases.

The downside to the stop limit, though, is the possibility that the price wont recover. Shares could gap down to 16, then drift to 15, 14 or lower before stabilizing. In this situation, the stop limit is never triggered, and the shareholder must make the agonizing decision to sell at a much lower price than anticipated or hang onto the stock in hopes of a rally that may never come.