A:

First, remember that a stop-loss order is a limit order placed with a broker to sell a stock when it reaches a certain price. It is designed to limit an investor's loss on a stock position. Therefore, limit orders do not apply to the trading of mutual fund shares. (For related reading, see The Basics Of Order Entry.)

To better understand this circumstance, it's worthwhile to look at the structure of a mutual fund and how shares of a fund are bought and sold. Unlike stocks, which are traded on a stock exchange, mutual fund shares are issued (bought by investors from the fund) and redeemed (sold by investors to the fund) by the fund, which is why the formal designation of the most prevalent form of a mutual fund is open-end.

Fund companies issue and redeem shares of an open-end mutual fund according to the desires of the investing public. At what prices are these transactions executed? Here is where we see a fundamental difference between the trading of stock and mutual fund shares.

In the case of stock, a company issues a finite number of shares and, after an initial public offering (IPO), these shares trade on the secondary market. A stock's share price is determined by the forces of supply and demand - in other words, the market sentiment among buyers and sellers.

Mutual fund shares are priced, for both purchase and sale, according to their net asset value (NAV). How is this value determined? In simple terms, a stock mutual fund has an underlying portfolio of stocks, and these stocks are "valued" according to their closing prices at the end of each day. A mutual fund's share price, therefore, is only determined once a day after trading is closed.

Obviously, stock prices march to a different drummer and constantly change throughout the trading day. When you buy or sell mutual fund shares on a Monday, you won't get a price fix until Tuesday.

Mutual funds can't be traded like stocks, which allow investors to use techniques such as limit orders, buying on margin, shorting, etc. Because of the trading limitations of mutual funds, professional investors pressured for a change, which resulted in the creation of the now very popular exchange-traded fund (ETF). An ETF is an index mutual fund that is listed on a stock exchange and can be traded with all the attributes of a stock.

To learn more about this investment vehicle, read Introduction To Exchange-Traded Funds.

RELATED FAQS
  1. Is my IRA/Roth IRA FDIC-Insured?

    The Federal Deposit Insurance Corporation, or FDIC, is a government-run agency that provides protection against losses if ... Read Full Answer >>
  2. How do I place an order to buy or sell shares?

    It is easy to get started buying and selling stocks, especially with the advancements in online trading since the turn of ... Read Full Answer >>
  3. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  4. How do I set a strike price in foreign exchange trading?

    In trading with a foreign exchange, a trader can set a strike price for a currency pair by entering a limit order or a stop ... Read Full Answer >>
  5. Is there a situation in which wash trading is legal?

    Wash trading, the intentional practice of manipulating a stock's activity level to deceive other investors, is not a legal ... Read Full Answer >>
  6. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
Related Articles
  1. Investing Basics

    What is a Settlement Date?

    A settlement date is the day a security trade must be settled.
  2. Investing Basics

    Explaining Risk-Adjusted Return

    Risk-adjusted return is a measurement of risk for an investment or portfolio.
  3. Investing

    Five Things to Consider Now for Your 401(k)

    If you can’t stand still, when it comes to checking your 401 (k) balance, focus on these 5 steps to help channel your worries in a more productive manner.
  4. Investing Basics

    Calculating the Margin of Safety

    Buying below the margin of safety minimizes the risk to the investor.
  5. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  6. Mutual Funds & ETFs

    ETF Analysis: Guggenheim Enhanced Short Dur

    Find out about the Guggenheim Enhanced Short Duration ETF, and learn detailed information about this fund that focuses on fixed-income securities.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares Morningstar Small-Cap Value

    Find out about the Shares Morningstar Small-Cap Value ETF, and learn detailed information about this exchange-traded fund that focuses on small-cap equities.
  8. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI KLD 400 Social

    Find out about the iShares MSCI KLD 400 Social exchange-traded fund, and learn detailed information about its characteristics, suitability and recommendations.
  9. Mutual Funds & ETFs

    ETF Analysis: Guggenheim BulletShrs 2018 HY CorpBd

    Find out about the Guggenheim BulletShares 2018 High Yield Corporate Bond ETF, and get information about this ETF that focuses on high-yield corporate bonds.
  10. Mutual Funds & ETFs

    ETF Analysis: PowerShares DWA SmallCap Momentum

    Find out about the PowerShares DWA SmallCap Momentum Portfolio ETF, and explore detailed analysis the fund's characteristics, suitability and recommendations.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Series 6

    A securities license entitling the holder to register as a limited ...
  3. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  4. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  5. At The Lowest Possible Price

    A type of security trading designation that instructs a brokerage ...
  6. At The Highest Possible Price

    A type of security trading designation that instructs a brokerage ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!