What Is a Stop-Loss Order?
A stop-loss order is an order placed with a broker to buy or sell a security when it reaches a certain price. Stop-loss orders are designed to limit an investor’s loss on a position in a security and are different from stop-limit orders. When a stock falls below the stop price the order becomes a market order and it executes at the next available price. For example, a trader may buy a stock and places a stop-loss order 10% below the purchase price. Should the stock drop, the stop-loss order would be activated, and the stock would be sold as a market order.
Although most investors associate a stop-loss order with a long position, it can also protect a short position, in which case the security gets bought if it trades above a defined price.
- A stop-loss order specifies that a stock be bought or sold when it reaches a specified price known as the stop price.
- Once the stop price is met, the stop order becomes a market order and is executed at the next available opportunity.
- In many cases, stop-loss orders are used to prevent investor losses when the price of a security drops.
The Stop Loss Order
Understanding Stop-Loss Orders
Traders or investors may choose to use a stop-loss order to protect their profits. It removes the risk of an order not getting executed should the stock continue to fall since it becomes a market order. A stop-limit order triggers once the price falls below the stop price; however, the order may not be executed due to the value of the limit portion of the order.
The one negative aspect of stop-loss is if a stock suddenly gaps lower below the stop price. The order would trigger, and the stock would be sold at the next available price even if the stock is trading sharply below your stop loss level.
A sell stop order refers to when a customer requests that a broker sell a security if it moves below a specified stop price. In a buy stop order, the stop price is set above the current market price.
Investors may further enhance the efficacy of their stop-loss order by combining it with a trailing stop. A trailing stop is a trade order where the stop-loss price isn't fixed at a specific dollar amount, but it is instead set at a certain percentage or dollar amount below the market price.
A Real World Example of a Stop-Loss Order
A trader buys 100 shares of XYZ for $100 and sets a stop loss order at $90. The stock declines over the next few weeks and falls below $90. The traders stop order gets executed and the position is sold at $89.95.
A trader buys 500 shares of ABC Corp. for $100 and sets a stop loss order for $90 again. This time the company reports horrible earnings results and the stock plunged by over 50%. When the market re-opens the trader's stop order is triggered, and the trade gets executed at a price of $49.50.