A stop-loss order, or stop order, is a type of advanced trade order that can be placed with most brokerage house. A stop loss order gives your broker a price trigger that protects you from a big drop in a stock. You enter a stop loss order at a point below the current market price. If the stock falls to this price point, the stop loss order becomes a market order and your broker sells the stock. If the stock stays level or rises, the stop loss order does nothing. This differs from a conventional market order, in which the investor simply specifies that he or she wishes to trade a given number of shares of a stock at the current market-clearing price. Thus, a stop-loss order is essentially an automatic trade order given by an investor to his or her brokerage. It will only become active and be executed once the price of the stock in question falls to the specified stop price stated in the investor's stop-loss order.To say in short, Stop loss orders are cheap insurance that protects you from a loss.For most stop-loss orders, the brokerage house normally looks at the prevailing market bid price (i.e. the highest price for which investors are willing to buy the stock at a given point in time), and if the bid price reaches the specified stop-loss price, the order is executed and the shares are sold. The bid price is used for stop-loss sell orders - instead of the ask price or the market-clearing price - because the bid price is the price a seller can receive presently in the market.
A stop-loss is designed to limit an investor's loss on a security position. Setting a stop-loss order for 10% below the price at which you bought the stock will limit your loss to 10%.
Positives and Negatives
The advantage of a stop order is you don't have to monitor on a daily basis how a stock is performing.
The disadvantage is that the stop price could be activated by a short-term fluctuation in a stock's price. The key is picking a stop-loss percentage that allows a stock to fluctuate day to day while preventing as much downside risk as possible. Setting a 5% stop loss on a stock that has a history of fluctuating 10% or more in a week is not the best strategy: you'll most likely just lose money on the commissions generated from the execution of your stop-loss orders.
There are no hard and fast rules for the level at which stops should be placed. This totally depends on your individual investing style: an active trader might use 5% while a long-term investor might choose 15% or more.
Another thing to keep in mind is that once your stop price is reached, your stop order becomes a market order and the price at which you sell may be much different from the stop price. This is especially true in a fast-moving market where stock prices can change rapidly.
A last restriction with the stop-loss order is that many brokers do not allow you to place a stop order on certain securities like OTC Bulletin Board stocks or penny stocks.
Not Just for Preventing Losses
Stop-loss orders are traditionally thought of as a way to prevent losses thus it's namesake. Another use of this tool, though, is to lock in profits, in which case it is sometimes referred to as a "trailing stop". Here, the stop-loss order is set at a percentage level below not the price at which you bought it but the current market price. The price of the stop loss adjusts as the stock price fluctuates. Remember, if a stock goes up, what you have is an unrealized gain, which means you don't have the cash in hand until you sell. Using a trailing stop allows you to let profits run while at the same time guaranteeing at least some realized capital gain. A Stop Loss Order can be placed only with a limit price.
A stop-loss is designed to limit an investor's loss on a security position. Setting a stop-loss order for 10% below the price at which you bought the stock will limit your loss to 10%.
Positives and Negatives
The advantage of a stop order is you don't have to monitor on a daily basis how a stock is performing.
The disadvantage is that the stop price could be activated by a short-term fluctuation in a stock's price. The key is picking a stop-loss percentage that allows a stock to fluctuate day to day while preventing as much downside risk as possible. Setting a 5% stop loss on a stock that has a history of fluctuating 10% or more in a week is not the best strategy: you'll most likely just lose money on the commissions generated from the execution of your stop-loss orders.
There are no hard and fast rules for the level at which stops should be placed. This totally depends on your individual investing style: an active trader might use 5% while a long-term investor might choose 15% or more.
Another thing to keep in mind is that once your stop price is reached, your stop order becomes a market order and the price at which you sell may be much different from the stop price. This is especially true in a fast-moving market where stock prices can change rapidly.
A last restriction with the stop-loss order is that many brokers do not allow you to place a stop order on certain securities like OTC Bulletin Board stocks or penny stocks.
Not Just for Preventing Losses
Stop-loss orders are traditionally thought of as a way to prevent losses thus it's namesake. Another use of this tool, though, is to lock in profits, in which case it is sometimes referred to as a "trailing stop". Here, the stop-loss order is set at a percentage level below not the price at which you bought it but the current market price. The price of the stop loss adjusts as the stock price fluctuates. Remember, if a stock goes up, what you have is an unrealized gain, which means you don't have the cash in hand until you sell. Using a trailing stop allows you to let profits run while at the same time guaranteeing at least some realized capital gain. A Stop Loss Order can be placed only with a limit price.
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