What Is a Stop-Loss Order?

A stop-loss order is a trade order placed with a broker to buy or sell a specific stock once the stock reaches a certain price, known as the stop price. Once the stop price is met, the order then becomes a market order and is executed at the next available opportunity. This type of order is designed to limit an investor’s loss on a position and is different from stop-limit orders.

The most common use of a stop-loss order is to set a sell order below the market price of a stock that an investor owns. By doing so, an investor can exit a trading position if the market moves against them, and limit their losses when the price of the stock moves to an undesirable level.

Once the stop price triggers a market order, the broker will seek the best execution, even if the price has moved away from the trigger price. This is one of the key caveats to be aware of with stop-loss orders: There is no guarantee that the execution price will be equal to or near the stop price. A buy stop-market order should be placed above the market price and a sell stop-market order should be placed below the market price.

Example of a Stop-Loss Order

For example, suppose that you own some stock that is currently selling for $60 per share. You expect it to increase in value but fear that if it starts to go down, perhaps at the announcement of bad news, then it will continue to slide further. In that case, you may wish to place a stop-loss order to sell the stock at market price with a stop price of $55. When the stock price hits $55 per share, the broker will look for the best market order to execute the trade.

Stop-Loss Versus Limit Order

Note that the stop price is very different from the limit price or a limit order. With a limit order, you will get the limit price or better, or the trade will not take place. This type of order is used when an investor wants to place limitations on the price received or paid for a stock. Once the price reaches the specified minimum price to be sold at or the maximum price to be bought at, the order is normally filled at that price or better if there is sufficient trading volume.

With a stop-loss order, the fall of the price to the stop price triggers the order. However, prices do not always move continuously, so the stock may fall below the stop price before your order is filled. A stop-loss order triggers a market order at a given price, while a limit order blocks a trade from being fully filled if the limit price cannot be met.

An investor can also place a stop-limit order. Such an order is triggered by the stock reaching the stop price, but it will not be executed unless a price at or better than the limit price can be obtained. When you place a stop-limit order, you must specify a stop order price as well as a limit price. A stop-limit order gives the trader precise control over when the order should be filled. The downside is that a stop-limit order will not be filled if the stock’s price moves beyond the boundaries established by the order. If the stop price isn’t reached, the trade will never be triggered.

Stop-limit orders can protect you when a big price move occurs. A stop-limit order will prevent a buy order from being filled at too high of a price and a sell order at too low of a price if the stock makes a big, fast move. This restriction may give an investor time to reevaluate the situation and to see if a more favorable price is reached in the days ahead, though it is possible that the stock will continue to move further away from the desired price range.

Conclusion

With a stop-loss order, the trader designates a stop price that triggers the broker to execute the trade order at the best market price available. Setting a stop-loss order is useful if an investor believes the price of a stock will fall with momentum past the stop price. However, there is no guarantee that the execution price will be equal to or near the stop price.

A stop-limit order gives investors more control over the order execution available through a stop-loss order. A trade order will still be triggered once the stock reaches the stop price, but the minimum price to be sold at placed on the trade will keep the stock from being sold outside a desirable range.