Stop loss and stop loss orders: which order to use?

Traders and investors who want to limit potential losses can use several types of orders to enter and exit the market when they may not be able to place orders manually. Stop-loss orders and stop-loss limit orders are two tools for this purpose. However, it is important to understand the difference between these two tools.

Key points

  • A sell stop loss order is a stop loss order. If the price is below a certain level, the market sell order is triggered to protect the long position.
  • A buy stop loss order is a stop loss order that protects a short position; it is set above the current market price and will be triggered if the price is higher than that level.
  • A stop-loss limit order is a type of stop-loss, but at the stop-loss price, the order becomes a limit order—only executed at the limit price or better.

Stop Loss Order

There are two types of stop orders: one is to protect long positions (sell-stop order), and the other is to limit the loss of short positions (buy-stop order).

Stop Loss Order

If the price falls below a certain level, a sell stop order protects the long position by triggering a market sell order. The basic assumption behind this strategy is that if the price falls so much, it may continue to fall more. Selling at this price can limit losses.

For example, suppose a trader owns 1,000 shares of ABC stock. They bought the stock for $30 per share and rose to $45 due to rumors that it might be acquired. Traders want to lock in earnings of at least $10 per share, so they place a stop loss order at $41. If the stock falls below this price, the order will become a market order and be filled at the current market price, which may be higher (or probably lower than) the stop loss price of $41. In this case, the trader may receive $41 for 500 shares and $40.50 for the rest. But they will retain most of the proceeds.

Buy stop loss order

A buy stop loss order is conceptually the same as a sell stop loss order. However, they are used to protect short positions. The price of a buy stop loss order will be higher than the current market price and will be triggered when the price is higher than that level.

Stop Loss Order

Stop loss orders are similar to stop loss orders. But as their name says, the price they execute is limited. Two prices are specified in a stop-loss limit order: a stop-loss price (converting an order into a sell order) and a limit price. A sell order will not become a market order to sell, but a limit order, which will only be executed at a limit price or better.

Of course, there is no guarantee that this order will be executed, especially if the stock price rises or falls rapidly. Stop-loss limit orders are used when the price of stocks or other securities falls below the limit price, but investors do not want to sell at the current low price and are willing to wait for the price to rise to the limit price. Price limit.

For example, continuing the above example, let us assume that the ABC stock will never fall to the stop loss price. Instead, it continued to rise and eventually reached $50 per share. Traders cancel their stop loss order at $41 and place a stop loss order at $47 with a limit price of $45. If the stock price drops below $47, the order will become a real-time limit order. If the stock price drops below $45 before the order is filled, the order will remain unfilled until the price rises to $45.

If the stock price falls below the limit price, many investors will cancel the limit order because they place the order only to limit losses when the price drops. Because they missed the opportunity to exit, they would just wait for the price to rise. They may not want to sell at that limit price at that time, in case the stock continues to rise.

Like buy stop-loss orders, buy stop-loss limit orders are used for short selling. At this time, investors are willing to take the risk to wait for the price to fall, if the purchase is not done at the limit price or a better price.

For active traders, it is important to take appropriate measures to protect their transactions from major losses.

Benefits and risks of stop-loss and stop-loss limit orders

Stop loss and stop loss orders can provide investors with different types of protection. Stop loss orders can be guaranteed to be executed, but price fluctuations and price slippage often occur during execution. Most stop-loss orders are filled at a price lower than the limit price; the difference depends largely on how fast the price falls. If the price plummets rapidly, the order may be filled at a fairly low price.

Stop-loss limit orders can guarantee the price limit, but the transaction may not be executed. If the order is not executed before the market price drops below the limit price, this will cause investors to suffer significant losses in the fast market. If bad news about the company comes out and the limit price is only $1 or $2 lower than the stop price, the investor must hold the stock indefinitely before the stock price rises again. Both types of orders can be entered as daily orders or Good Till Cancellation (GTC) orders.

Choosing which type of order to use basically boils down to deciding which type of risk is more suitable to bear. The first step in doing so is to carefully evaluate the trading situation of the stock.

If the stock price fluctuates greatly and the price fluctuates greatly, then the stop-loss limit order may be more effective because it has a price guarantee. If the transaction is not executed, then investors may only have to wait a short time before the price will rise again. For example, if bad news comes out that a company has doubts about its long-term future, a stop loss order will be appropriate. In this case, the stock price may not return to its current level for months or years (if any). Therefore, it is wise for investors to reduce losses and sell at market prices. If the stop loss order is not executed, it may eventually incur considerable losses.

Another important factor to consider when placing an order is where to set the stop loss and limit price. Technical analysis may be a useful tool here; stop-loss prices are usually located at technical support or resistance levels. Investors who place stop-loss orders on steadily rising stocks should pay attention to giving the stock a little room to fall back. If they set the stop price too close to the current market price, they may be stopped because the price retracement is relatively small. They may also miss the opportunity for prices to start rising again.

Can stop orders be used to protect the profits of long and short positions?

Yes they can. In this case, the term “stop loss order” is a bit misnomer. Although the basic application of stop-loss orders is to prevent large losses in long or short positions, they can also be used to protect the income of existing positions because they are activated when the price of a security trades above a certain level. However, because once the specified price level is exceeded, they will be converted into market orders, so the actual price of the transaction execution may be much lower than the stop loss price (for sell stop orders) or higher than the stop price price (for buying Stop loss order).

Will investors be affected by the use of stop-loss orders?

Yes, investors may be shocked by the use of stop-loss orders. For example, when a stop loss order is executed, their long positions may be liquidated, but if the stock subsequently reverses and trades higher, then if they insist instead, the losing position may actually be profitable early. sold.

How do I determine at what level I should set the stop loss level?

Technical analysis is very useful for determining the level at which a stop loss should be set. For example, for long positions, identifying key support levels for stocks is useful for measuring downside risks. The premise here is that once the key support level collapses, it may indicate that the stock will suffer additional losses. However, be aware of false breakthroughs. Make sure to use technical analysis and other tools to carefully study the stop loss level before entering it into the trading platform.

Are stop loss and stop loss orders foolproof?

Unfortunately, stop-loss orders and stop-loss orders are not foolproof, and there is no guarantee that your losses will be limited to the required level. Since once the stop loss level is broken, the stop loss order will become a market order, so it may be executed at a price significantly away from the stop loss price. When using a stop-loss limit order, the risk is that the transaction may not be executed at the specified limit price. Both types of orders have pros and cons, so make sure to do your homework and understand the differences before placing an order.

Bottom line

Stop loss and stop loss orders can provide different types of protection for long and short investors. Stop-loss orders are guaranteed to be executed, and stop-loss orders are guaranteed to be price.


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