What Is Soft Stop Order?

A soft stop order is a mental reminder set by a trader to consider placing an order once a particular price is reached.

Key Takeaways

  • Soft stop orders are mental reminders used by traders to buy or sell a stock at a given price.
  • Hard stop orders, which are those already submitted to a broker, are the opposite of soft stop orders.
  • Soft stop orders can offer greater flexibility, although whether this helps or hinders investors will depend on their own psychology.

Understanding a Soft Stop Order

A stop order is an order to buy or sell a security once its price has crossed a particular threshold. A stop order is "soft" if it has not yet been submitted to a broker but instead is merely an intention in the trader's mind. In that circumstance, the intention can be modified or ignored depending on market conditions and the judgment of the trader. By contrast, a regular (or "hard") stop order is one that has already been placed with a broker.

A trader might want to cut their losses, for example, and sell a stock if its price declines by more than 20%. However, instead of issuing an order to that effect, they may feel more comfortable using a soft stop order so that they can reconsider their decision in light of the market conditions and other new information available at that time.

Traders will often use a soft stop order when they have a price in mind at which to buy or sell a security but they do not want to commit to that price by issuing a formal stop order. This might be because the trader wants to reserve some subjectivity to see how overall market sentiment appears to be once the price reaches that pre-defined level.

Traders may also set a mental percentage move, such as considering buying shares once the price falls by 10%, relative to its current level.

Soft stop orders can be helpful or harmful depending on the psychology of the investor. On the one hand, they can protect investors against committing to poorly thought out decisions. After all, traders who opt for a soft stop order can take time to conduct further research before committing to their trade. On the other hand, soft stop orders could also undermine traders' discipline, allowing them to postpone or ignore difficult decisions that would nonetheless be in their long-term interest.

Soft Stop Order Example

Suppose you are a value investor. As part of your investment methodology, you maintain a watchlist of companies that you would like to buy, provided their prices decline to more attractive levels.

One of the companies on your list is XYZ Corporation, a company you have long wanted to buy but which has always been too expensive for your liking. Its current share price is $50 per share, and you have long maintained that you would buy it at $45 or better. Once you have bought this, you have a soft stop order whereby you would get out of it if it fell to $30, but you will not place a hard order at this level.

One morning, XYZ issues a press release announcing a recall for one of their largest products. The market reacts with panicked selling, sending the price plummeting to $40 per share. At first, you cannot believe your luck. For years you have waited for an opportunity to buy XYZ shares, and now that opportunity has finally come. But since you never formally entered your order to buy at $45 per share, you can pick up the desired amount of shares at $40. Now, that soft stop order at $30 that you had decided on is in play.

As more information pours in about the product recall, the price continues its downward trajectory to where it approaches $30. At this point you have a decision to make. Should you trust your prior risk management strategy and get out of this position for a loss of $10 per share or should you amend your soft stop order lower, to maybe $25, and see if the selling pressure abates. After all, you had long thought of XYZ as a well managed company that would add value to your portfolio.

Ultimately, you decide to trust your previous research and lower your soft stop order. However, this episode reminds you of how investor psychology can play an important role when using soft stop orders to make investments.