Stop-Loss Order

Definition of '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 an investor’s loss on a position in a security. Although most investors associate a stop-loss order only with a long position, it can also be used for a short position, in which case the security would be bought if it trades above a defined price. A stop-loss order takes the emotion out of trading decisions and can be especially handy when one is on vacation or cannot watch his/her position. However, execution is not guaranteed, particularly in situations where trading in the stock is halted or gaps down (or up) in price. Also known as a “stop order” or “stop-market order.”

Investopedia explains 'Stop-Loss Order'




With a stop-loss order for a long position, a market order to sell is triggered when the stock trades below a certain price, and it will be sold at the next available price. This type of order works well if the stock or market is declining in an orderly manner, but not if the decline is disorderly or sharp.

For example, if you own shares of ABC Co., which is currently trading at $50, and want to hedge against a big decline, you could enter a stop-loss order to sell your ABC holdings at $48. This type of stop-loss order is also called a sell-stop order. If ABC trades below $48, your stop-loss order is triggered and converts into a market order to sell ABC at the next available price. If the next price if $47.90, your ABC shares would be sold at $47.90.

But what if ABC closes at $48.50 one day, and then reports weak quarterly earnings after market close? If the stock gaps down, and opens at $44.90 the next day, your stop-loss order would be automatically triggered and your shares sold at the next available price, say $45. In this case, your stop-loss order did not work out as you expected, since your loss on ABC is 10% rather than the 4% you had expected when you placed the stop-loss order.

This is a major drawback of stop-loss orders, and is a reason why experienced investors use stop-limit orders instead of stop-market orders. Stop-limit orders seek to sell the stock at a specified limit price – rather than the market price – once a specified price level is breached. Although stop-limit orders will also not work if the stock is halted down or has a price gap, the risk of the long position being sold at a significantly lower price than the specified stop price is lower than with a stop-market order.

Note that these orders can also be used to protect unrealized gains, although in this case it would be more accurate to refer to them as stop orders rather than stop-loss orders.

Go deeper by reading our article on The Stop-Loss Order - Make Sure You Use It.



Related Video for 'Stop-Loss Order'

comments powered by Disqus
Hot Definitions
  1. Joint Venture - JV

    A business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity. In a joint venture (JV), each of the participants is responsible for profits, losses and costs associated with it.
  2. Aggregate Risk

    The exposure of a bank, financial institution, or any type of major investor to foreign exchange contracts - both spot and forward - from a single counterparty or client. Aggregate risk in forex may also be defined as the total exposure of an entity to changes or fluctuations in currency rates.
  3. Organic Growth

    The growth rate that a company can achieve by increasing output and enhancing sales. This excludes any profits or growth acquired from takeovers, acquisitions or mergers. Takeovers, acquisitions and mergers do not bring about profits generated within the company, and are therefore not considered organic.
  4. Family Limited Partnership - FLP

    A type of partnership designed to centralize family business or investment accounts. FLPs pool together a family's assets into one single family-owned business partnership that family members own shares of. FLPs are frequently used as an estate tax minimization strategy, as shares in the FLP can be transferred between generations, at lower taxation rates than would be applied to the partnership's holdings.
  5. Yield Burning

    The illegal practice of underwriters marking up the prices on bonds for the purpose of reducing the yield on the bond. This practice, referred to as "burning the yield," is done after the bond is placed in escrow for an investor who is awaiting repayment.
  6. Marginal Analysis

    An examination of the additional benefits of an activity compared to the additional costs of that activity. Companies use marginal analysis as a decision-making tool to help them maximize their profits. Individuals unconsciously use marginal analysis to make a host of everyday decisions. Marginal analysis is also widely used in microeconomics when analyzing how a complex system is affected by marginal manipulation of its comprising variables.
Trading Center