What is a stop loss order?
A stop-loss order is an order to a broker to buy or sell a security when the security reaches a specific price. A stop-loss order is designed to limit an investor’s loss on a security position, unlike a stop-limit order. When the stock falls below the stop price, the order becomes a market order and is executed at the next available price. For example, a trader might buy a stock and place a stop-loss order at 10% below the purchase price. If the stock falls, the stop loss order will be activated and the stock will be sold as a market order.
While most investors associate a stop-loss order with a long position, it can also protect a short position, in which a security is bought if it trades above a stated price.
- A stop order specifies to buy or sell a stock when it reaches a specified price called the stop price.
- Once the stop price is reached, the stop order becomes a market order and is executed at the next available opportunity.
- In many cases, stop-loss orders are used to prevent investors from losing money when the price of a security falls.
Understanding Stop Loss Orders
Traders or investors can choose to use stop-loss orders to protect their profits. It removes the risk of the order not being executed if the stock continues to fall as it becomes a market order. A stop-limit order is triggered once the price falls below the stop price; however, the order may not be executed due to the value of the limit portion of the order.
One downside of a stop loss is if the stock suddenly gaps below the stop loss price. The order will trigger and the stock will be sold at the next available price even if the stock is trading well below your stop loss level.
A sell stop order is when a client asks the broker to sell a security when it falls below the specified stop price. In a buy stop order, the stop price is set above the current market price.
Investors can further increase the effectiveness of stop-loss orders by combining them with trailing stops. A trailing stop is a trade order in which the stop price is not fixed at a specific amount, but is set at a certain percentage or amount below the market price.
A real example of a stop loss order
A trader buys 100 shares of XYZ stock at $100 and places a stop loss order at $90. The stock fell and fell below $90 over the next few weeks. The trader’s stop order is executed and the position is sold at $89.95.
A trader buys 500 shares of ABC Corp. at $100 and places a stop-loss order again at $90. This time around, the company reported poor earnings results, and the stock plunged more than 50%. When the market reopened, the trader’s stop-loss order was triggered and the trade was executed at $49.50.