A stop-loss order is an order to sell (or buy) a stock at the prevailing market price once the stock reaches a specific level known as the stop price. It is designed to limit an investor's loss on a stock position if the market unexpectedly reverses.
Neither stop-loss orders nor the related stop-loss limit order apply to the trading of mutual fund shares. That's because the only price applicable to shares of an open-end mutual fund is the net asset value, which is calculated after the close of market every day.
- A stop-loss order cannot be placed for shares of a mutual fund because the per-unit price of fund shares is based solely on one figure, the daily net asset value.
- A stop-loss order applies to shares of stock that are actively traded; it becomes a market order once the market reaches the stop price.
- A mutual fund's net asset value is determined by subtracting the value of a fund's liabilities from the value of its assets and dividing the result by the number of a mutual fund's outstanding shares.
- A fund's assets are the securities it invests in using the pooled funds of investors.
- No matter the time of day an order to buy or sell fund shares is placed, it isn't fulfilled until after the market closes and the net asset value is established.
Trading Mutual Funds vs. Stocks
Orders for Mutual Fund Shares
To better understand this circumstance, it's worth looking at the structure of a mutual fund and how shares of a fund are bought and sold.
The traditional mutual fund is an open-end fund which issues unlimited numbers of shares, according to the demand for them by investors. Money flows into and out of open-end funds as investors buy and sell their shares.
Investors may place orders throughout any business day to buy or sell mutual fund shares. However, no order can be executed until after the market closes. When they are, they're all executed at the same price for that day. That's because the price for mutual fund shares corresponds to the net asset value (NAV) of the fund and that is calculated after the close of the trading day.
Orders for Shares of Stock
The transaction process is different for stocks. In the case of stock, a company issues a finite number of shares and, after an initial public offering (IPO), these shares trade in the secondary market. A stock's share price is determined by the forces of supply and demand—in other words, the market sentiment that exists among buyers and sellers.
Shares of stock trade on a stock exchange. They can be bought and sold during the hours that the exchange is open for business. Shares of stock trade at prevailing market prices, which change throughout any trading day.
For instance, investors can instruct that orders for their shares be executed at the market or at a specific (limit) price. There are a variety of order types related to stocks.
Shares of stock change hands a vast number of times at various prices throughout any trading day.
A closed end fund is not an open-end fund that has closed to new investors. A closed end fund is an investment company with shares that trade on the open market, after an initial public offering. It doesn't sell to the public or redeem their shares.
Determining Net Asset Value
As mentioned, mutual fund shares are priced, for both purchase and sale, according to their net asset value, or NAV. How is this value determined?
Net asset value = Fund assets minus fund liabilities/number of outstanding shares
For example, a stock mutual fund's assets are the stocks in its portfolio. These stocks are valued according to their closing prices at the end of each day. A mutual fund's net asset value is then determined by totaling the value of all its investments and subtracting from that the value of its liabilities. That result is then divided by the number of shares the mutual fund has issued. Once net asset value is established, orders from fund customers can be filled.
What Is a Stop-Loss Order?
A stop-loss order is an order to sell (or buy) a stock at the market once the stock's price reaches the stop price. It is used to reduce a trader's exposure to loss should the market turn against their position.
Why Can't Mutual Funds Accept Stop-Loss Orders?
They can't accept a stop-loss order because such an order doesn't correspond to the way mutual fund shares are priced or traded. Shares in an open-end mutual fund are both bought and sold at a single price that's established at the end of every business day after the market closes. Since just one price is available, and orders are filled after the market is closed, a stop-loss order doesn't apply.
When Are Orders to Buy Mutual Fund Shares Filled?
No matter what time during the day that an investor places their order to buy or sell fund shares, the order can only be filled after the price for the shares, or net asset value (NAV), is determined. The NAV can only be determined after the market closes.
The Bottom Line
Mutual funds can't be traded like stocks because they are priced differently. While stocks allow investors to place various types of order, such as stop-loss orders, market orders, limit orders, good-til-canceled orders, and more, mutual fund shares can be bought or sold only at a single price per day.
The trading limitations of mutual funds spurred professional investors to press for alternatives. This resulted in the creation of the popular exchange-traded fund. An ETF is an index mutual fund that is listed on a stock exchange and can be traded at various prices throughout the trading day, as stocks are.