Loading the player...
A:

A stop-loss order, or stop order, is a type of advanced trade order that can be placed with most brokerages. The order specifies that an investor wants to execute a trade for a given stock, but only if a specified price level is reached during trading. This differs from a conventional market order, in which the investor simply specifies that he or she wishes to trade a given number of shares of a stock at the current market-clearing price.

Thus, a stop-loss order is essentially an automatic trade order given by an investor to his or her brokerage. It will only be executed once the price of the stock in question falls to the specified stop price stated in the investor's stop-loss order.

For example, let's say you are long 10 shares of Tesla Inc. (TSLA) which you bought for $315.00 per share. The shares are now trading for $340.00 per share. You want to continue holding the stock so you can participate in any future price appreciation it may see. However, you also don't want to lose all of the unrealized gains you have built up so far with the stock, and you would want to sell out of your position if TSLA shares fell to $325.50.

Rather than watching the market five days a week to make sure the shares are sold if Tesla's price drops, you can simply enter a stop-loss order to essentially monitor the price for you. You could input a stop-loss sell order to your brokerage to sell 10 shares of XYZ if its price falls to $325.50

For most stop-loss orders, the brokerage house normally looks at the prevailing market bid price (i.e. the highest price for which investors are willing to buy the stock at a given point in time), and if the bid price reaches the specified stop-loss price, the order is executed and the shares are sold. The bid price is used for stop-loss sell orders - instead of the ask price or the market-clearing price - because the bid price is the price a seller can receive presently in the market. In our example, a stop-loss order placed for 10 shares of TSLA at $325.50 would effectively limit your potential losses, and you still get to realize a profit of $325.50 - $315.00 = $10.50 per share should the stock price head south.

Stop-loss orders can also be used to limit losses in short-sale positions. If you are short a given stock, you can issue a stop-loss buy order at a specified price. This order will be executed only if the stock's price rises high enough to reach the stop-loss price, triggering a buy order execution and closing out your short position in the stock. In these cases, the stop-loss order would be executed once the ask price level reaches the stop-loss price, since the ask price is the price at which an investor is able to buy shares on the open market. (For more on this, see Can a stop-loss order be used to protect a short sale transaction? )

To read more on this topic, check out The Stop-Loss Order - Make Sure You Use It, The Basics of Order Entry and Trailing-Stop Techniques.

RELATED FAQS
  1. What is the difference between a stop loss order and a limit order?

    Learn how to manage losses and reduce risk in volatile markets while reviewing the differences between stop-loss orders and ... Read Answer >>
  2. How risky are stop loss orders?

    Understand the purpose and uses of a stop-loss order as a risk management tool for trading and also the risk associated with ... Read Answer >>
  3. How do I place a stop loss order?

    Learn how to place a stop-loss order and how traders use stop orders to either limit potential losses or to protect part ... Read Answer >>
  4. What types of investors are best-suited for stop loss orders?

    Use a stop-loss order to mitigate downside risk. Whether you are a conservative beginner or a seasoned day trader, a stop ... Read Answer >>
  5. How do I place a limit order online?

    Learn how a limit order is placed, the types of stocks it is most useful for and the specifications placed with it to suit ... Read Answer >>
  6. How can I use a stop order to limit my losses on a long stock position?

    Learn about stop orders, different stop order types, and how to use stop-loss orders and stop-limit orders to limit losses ... Read Answer >>
Related Articles
  1. Trading

    The Stop-Loss Order - Make Sure You Use It

    It's a simple but powerful tool to help you implement your stock-investment strategy. Find out how.
  2. Small Business

    A Look At Exit Strategies

    Setting appropriate exit points should help you avoid taking premature profits or running losses.
  3. Trading

    Which Order to Use? Stop-Loss or Stop-Limit Orders

    Stop-loss and stop-limit orders can provide different types of protection for investors seeking to lock in profits or limit losses. Investors need to know how each type of order works to know ...
  4. Investing

    Are Stop-Loss Orders and ETFs a Good Idea?

    Using stop-loss orders can be beneficial as well as risky. Do they make sense when trading ETFs?
  5. Managing Wealth

    Can You Buy Stock Insurace? 3 Strategies to Limit Stock Losses

    Investors can use derivative securities to effectively buy insurance on their individual holdings or on their portfolio as a whole.
  6. Investing

    The Basics of Trading a Stock: Know Your Orders

    Taking control of your portfolio means knowing what orders to use when buying or selling stocks.
  7. Trading

    How To Place Orders With A Forex Broker

    Learn how to set each type of stop and limit when trading currencies.
RELATED TERMS
  1. Stop-Loss Order

    An order placed with a broker to sell a security when it reaches ...
  2. Stopped Out

    The execution of a stop-loss order. Stopped out refers to when ...
  3. Bracketed Buy Order

    A buy order that is accompanied by a sell limit order above the ...
  4. Aggregate Stop-Loss Insurance

    A policy designed to limit claim coverage (losses) to a specific ...
  5. Gather In The Stops

    A trading strategy of driving down a stock's price by selling ...
  6. Risk/Reward Ratio

    A ratio used by many investors to compare the expected returns ...
Hot Definitions
  1. Contango

    A situation where the futures price of a commodity is above the expected future spot price. Contango refers to a situation ...
  2. Stop-Loss Order

    An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit ...
  3. Acid-Test Ratio

    A stringent indicator that indicates whether a firm has sufficient short-term assets to cover its immediate liabilities. ...
  4. Floating Exchange Rate

    A country's exchange rate regime where its currency is set by the foreign-exchange market through supply and demand for that ...
  5. Taxes

    An involuntary fee levied on corporations or individuals that is enforced by a level of government in order to finance government ...
  6. Impaired Asset

    A company's asset that is worth less on the market than the value listed on the company's balance sheet. This will result ...
Trading Center