DEFINITION of Soft Stop Order
A soft stop order (or mental stop) is a price or percentage move established in one's mind, set by traders where they will place a buy or sell order. A soft stop order is a position set by traders where they should buy or sell a security, however it is "soft" because it can be manipulated or changed depending on market conditions and special circumstances.
While a regular (or, "hard") stop order is an order which has already been placed to buy or sell a security at a certain point, soft stop orders are used as more of a guide for traders to consider buying or selling at a certain point, taking other factors such as market sentiment and momentum into consideration.
BREAKING DOWN Soft Stop Order
Traders will often use a soft stop order when they have a specific price level for a security in mind at which to buy or sell, but which they do not want to commit to by using a proper stop order. This may be because the trader wants to reserve some subjectivity to see how overall market sentiment appears once the price reaches that pre-defined mental price. A trader may also set a mental percentage move, for instance to consider buying shares of a company's stock once it has fallen 10% from its current price level.
Technical traders may use a soft stop to enter or exit a position based on shifting resistance or support levels in a particular asset. Short stops also help with regret aversion, where a trader ultimately regrets the decision to make a trade in retrospect. By having the flexibility to move the stop price, regret can be alleviated. On the other hand, if the soft stop ends up being too flexible, a trader may ultimately regret not having a fixed price level to stop them out.
Example of a Soft Stop
Take as an example, a trader in XYZ stock may purchase 1,000 shares at $26.50, but establish have a soft, or mental stop at $25.00 at which she should sell out of the position rather than risk further losses. However, an actual stop order is not placed with a broker at this price - instead, if the price does move down toward $25.00, the trader will re-evaluate his previous loss limit based on the current market and then decide to execute a sell order to exit the trade to move his mental stop lower. Market conditions changing constantly over time, and so a trader may decide that they will close out their position in XYZ shares in fact at $24.50 - or perhaps higher, at $25.25. The actual exit level of the trade will thus depend on what the market is doing at that moment - rather than committing blindly to the $25.00 level outright, regardless of changing sentiment.