Stoploss is a buy or sell order which gets triggered automatically, once the stock reaches a certain price. The aim here is to limit the loss on a security (buy or sell) position.
A stop order to sell becomes a market order when the item is offered at or below the specified price. E.g.: If you have bought 1 share of RIL at Rs. 1,050, you will enter stoploss order at a price below Rs. 1,050, say Rs. 1,020. If RIL share price falls to Rs. 1,020, a sell stoploss order will get triggered, which limits your loss on account of purchase to Rs. 30.
Similarly, a stop order to buy becomes a market order when the item is bid at or above the specified price. E.g.: If you have short-sold 1 share of RIL at Rs. 1,050, you will enter stoploss order at a price above Rs. 1,050, say Rs. 1,070. If RIL share price rises to Rs. 1,070, a buy stoploss order will get triggered, which will limit your loss on account of sale to Rs. 20.
There are no set rules for stoploss orders. Traders deploy very tight stoploss orders, while investors may not need it also. Advantage of stoploss is it avoids the need for constant monitoring of share price. Its disadvantage is that short-term price fluctuations could trigger stoploss orders very frequently. Also, setting very narrow stoploss for shares historically having wide price fluctuations could lead to unnecessary triggers of stoploss.
E.g.: If you bought 1 share of RIL at Rs. 1050 with stoploss of Rs. 1020. This means that if the stock falls below 1020, your stoploss order will automatically become a market order and share will be sold at the then prevailing market price, not necessarily the stoploss price. Thus setting a stoploss order below the purchase price will limit the loss, but in a very fast-moving market, losses may be higher than expected.