What Is a 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.

For example, a trader might want to cut their losses 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.

Key Takeaways

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

Understanding Soft Stop Orders

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.

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. Similarly, 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.

Real World Example of a Soft Stop Order

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 share price is $50 per share, and you have long maintained a soft stop order whereby you would buy it for $30 or less.

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 $25 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 $30 per share, instead relying on a soft stop order, you now need to decide whether to follow through on the decision.

As more information pours in about the product recall, you find yourself becoming scared. Should you trust your prior research and buy the shares, even though all the market commentators are stating that XYZ's business is severely damaged? Or should you reverse course and mentally cancel your soft stop order?

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