What is Stopped Out
Stopped out is a term used in reference to the execution of a stop-loss order. Often times, the term stopped out is used when a trade unexpectedly hits a stop-loss point and the trader generates a loss.
BREAKING DOWN Stopped Out
Stop-loss orders are an effective strategy for limiting potential losses, but they may be unexpectedly executed during times of high volatility. Often times, the term stopped out is used in a negative connotation when a trader’s position is unexpectedly sold. Traders can be stopped-out while being either long or short in any type of security where stop-loss orders can be placed, but it’s often used by day traders in the equity and index futures markets.
Traders are often stopped out when a market whipsaws – or moves sharply in one direction before returning to its original state. For example, a stock may whipsaw during an earnings announcement or other market moving event.
Example of Stopped Out
Suppose a day trader buys 100 shares of stock at $100.00 per share and sets a stop-loss at $98.00 and a take-profit at $102.00 ahead of a key earnings announcement. After the earnings announcement, the stock may move sharply lower to $95.00. The day trader would have been stopped out at $98.00 due to the stop-loss point, despite believing that shares wouldn’t have reacted that negatively to the news.
Avoiding Being Stopped Out
Traders have a couple different options to avoid getting stopped out, including keeping stop-loss levels in mind and using stock options to hedge against a decline.
A mental stop involves keeping a stop-loss price in mind rather than placing an actual order. By doing so, the trader can avoid being stopped out during a whipsaw. The risk is that the whipsaw never occurs and the stock continues to move in the wrong direction. In many ways, mental stops negate the entire purpose of using stop-loss points to mitigate risks since there’s no guarantee that the trader will remember or choose to actually sell shares.
Many traders use options as an alternative to stop-loss orders. By using put options, traders can hedge a stock position without actually selling the shares. For example, a trader who owns 100 shares of a stock may purchase a put option on those shares with a strike price equal to the desired stop-loss point. If the stock were to whipsaw, the option trade would protect against downside without prematurely selling the shares.
The Bottom Line
The term stopped out refers to the execution of a stop-loss order. Often times, the term is used as a negative statement when a stop-loss level was accidentally hit during a period of high volatility. Traders can mitigate the risk of being stopped out by using stock options instead of stop-loss orders to control for risk factors.