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What is a 'Stop-Loss Order'
A stop-loss order is an order placed with a broker to 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. 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.
certain price. Stop loss orders are designed to limit an investor’s loss on a position in a
security. 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.
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BREAKING DOWN 'Stop-Loss Order'
A stop-loss order takes the emotion out of trading decisions and can be useful if a
trader is on vacation or cannot watch his or her position. However, execution is not
guaranteed, particularly in situations where trading in the stock halts or gaps down
(or up) in price. A stop-loss order may also be referred to as a “stop order” or
“stop-market order.”
trader is on vacation or cannot watch his or her position. However, execution is not
guaranteed, particularly in situations where trading in the stock halts or gaps down
(or up) in price. A stop-loss order may also be referred to as a “stop order” or
“stop-market order.”
If an investor uses a stop-loss order for a long position, a market order to sell is
triggered when the stock trades below a certain price; the order then gets filled at the
next available price. This type of order works efficiently in an orderly market; however,
if the market is falling quickly, investors may get a fill well below their stop-loss order
price. For further reading, see: The Stop-Loss Order - Make Sure You Use It.
triggered when the stock trades below a certain price; the order then gets filled at the
next available price. This type of order works efficiently in an orderly market; however,
if the market is falling quickly, investors may get a fill well below their stop-loss order
price. For further reading, see: The Stop-Loss Order - Make Sure You Use It.
Stop-Loss Order Example
If you own shares of ABC Inc., which is currently trading at $50, and want to hedge
against a significant decline, you could enter a stop-loss order to sell your ABC holdings
at $48. This type of stop-loss order is also called a sell-stop order. If ABC trades below
$48, your stop-loss order is triggered and converts into a market order to sell ABC at
the next available price. If the next price if $47.90, your ABC shares sell at $47.90.
against a significant decline, you could enter a stop-loss order to sell your ABC holdings
at $48. This type of stop-loss order is also called a sell-stop order. If ABC trades below
$48, your stop-loss order is triggered and converts into a market order to sell ABC at
the next available price. If the next price if $47.90, your ABC shares sell at $47.90.
Stop-Loss Order Gapping
Suppose ABC closes at $48.50 and then reports weak quarterly earnings after the
market close. If the stock gaps lower and opens at $44.90 the next day, your stop-loss
order would be automatically triggered and your shares sell at the next available price,
say $45. In this case, your stop-loss order did not execute as expected, and as a result
your loss on ABC is 10% rather than the 4% you had expected when you placed the
top-loss order.
market close. If the stock gaps lower and opens at $44.90 the next day, your stop-loss
order would be automatically triggered and your shares sell at the next available price,
say $45. In this case, your stop-loss order did not execute as expected, and as a result
your loss on ABC is 10% rather than the 4% you had expected when you placed the
top-loss order.
Price gapping is a major drawback of stop-loss orders and a reason why many
experienced investors use stop-limit orders instead of stop-market orders. Stop-limit
orders seek to sell the stock at a specified limit price – rather than the market price –
once a specified price level gets breached. Although stop-limit orders do not offer
investors a perfect solution, they do reduce the risk of a long position selling at a price
that is significantly below a stop-market order.
experienced investors use stop-limit orders instead of stop-market orders. Stop-limit
orders seek to sell the stock at a specified limit price – rather than the market price –
once a specified price level gets breached. Although stop-limit orders do not offer
investors a perfect solution, they do reduce the risk of a long position selling at a price
that is significantly below a stop-market order.
Price gapping is reduced in markets that trade 24 hours, such as forex and
cryptocurrency. Investors still need to be aware that prices can gap below or above
stop-loss orders due to adverse macro news, or times of low liquidity. For example,
the price of bitcoin could gap lower if regulators announce a new tax for goods and
services that are purchased using the cryptocurrency. (Want to invest in bitcoin, but
don’t know where to start? For more, see: Basics for Buying and Investing in Bitcoin.)
cryptocurrency. Investors still need to be aware that prices can gap below or above
stop-loss orders due to adverse macro news, or times of low liquidity. For example,
the price of bitcoin could gap lower if regulators announce a new tax for goods and
services that are purchased using the cryptocurrency. (Want to invest in bitcoin, but
don’t know where to start? For more, see: Basics for Buying and Investing in Bitcoin.)
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