Loading the player...
A:

A stop-loss order, or stop order, is a type of advanced trade order that can be placed with most brokerage houses. 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 become active and 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 100 shares of XYZ Corporation. You bought the shares at $20, and now they are trading at $30 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 XYZ shares fell to $25.

Rather than watching the market five days a week to make sure the shares are sold if XYZ'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 100 shares of XYZ if its price falls to $25.

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 100 shares of XYZ at $25 would effectively limit your potential losses, ensuring you are able to sell your shares for $25 should your stock 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 learn more, check out The Stop-Loss Order - Make Sure You Use It, The Basics Of Order Entry and

Trailing-Stop Techniques.

RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. 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 >>
  4. What is the difference between a stop and a market order?

    Learn about market orders and stop orders, how they are used and executed, and the main difference between stop orders and ... Read Answer >>
  5. Do stop or limit orders protect you against gaps in a stock's price?

    Many individuals are hesitant to invest in the stock market because of the large gaps in prices talked about in the news. ... Read Answer >>
  6. What's the difference between a stop and a limit order?

    A limit order is an order that sets the maximum or minimum at which you are willing to buy or sell a particular stock. With ... Read Answer >>
Related Articles
  1. Small Business

    A Look At Exit Strategies

    Setting appropriate exit points should help you avoid taking premature profits or running losses.
  2. Investing

    3 Cases When Not to Place Tight Stop-Loss Orders (IBB, XBI)

    Learn about using stop-loss orders for exchange-traded funds. Discover the circumstances when using a tight stop-loss order may not be appropriate.
  3. Trading

    How To Place Orders With A Forex Broker

    Learn how to set each type of stop and limit when trading currencies.
  4. Investing

    Making The Trade: Understand Order Types

    Buying and selling stock can be a lot like buying or selling a car. Traders should use and understand tools such as market orders, limit orders, day orders, and good-'til-canceled orders to ensure ...
  5. Trading

    Introduction To Order Types

    A trade order is an instruction that is sent to a broker to enter or exit a position. Learn about the various types available to investors.
  6. Investing

    Narrow Your Range With Stop-Limit Orders

    With stop-limit orders, buyers protect themselves from prices too high for their tastes.
RELATED TERMS
  1. Stopped Out

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

    A buy order that is accompanied by a sell limit order above the ...
  3. Below The Market

    An order to buy or sell a security at a price that is lower than ...
  4. Bracketed Sell Order

    A sell order on a short sale that is accompanied (or "bracketed") ...
  5. Away From The Market

    An expression that is used when the bid on a limit order is lower ...
  6. At The Highest Possible Price

    A type of security trading designation that instructs a brokerage ...
Hot Definitions
  1. Index

    A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is a hypothetical ...
  2. Return on Market Value of Equity - ROME

    Return on market value of equity (ROME) is a comparative measure typically used by analysts to identify companies that generate ...
  3. Majority Shareholder

    A person or entity that owns more than 50% of a company's outstanding shares. The majority shareholder is often the founder ...
  4. Competitive Advantage

    An advantage that a firm has over its competitors, allowing it to generate greater sales or margins and/or retain more customers ...
  5. Mutual Fund

    An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities ...
  6. Wash-Sale Rule

    An Internal Revenue Service (IRS) rule that prohibits a taxpayer from claiming a loss on the sale or trade of a security ...
Trading Center