Description
A "Stop-Loss" order is a type of order that is placed with a broker or investment firm to sell a security when it reaches a certain price. It is designed to limit an investor’s loss on a security position. A stop-loss order is an instruction to the broker to sell a security when it reaches a certain price, known as the stop price. Once the security trades at or below the stop price, the order becomes a market order and is filled at the prevailing market price.
Stop-Loss orders are used to limit the amount of money that can be lost on a single trade. When the stop-price is reached, the trade is automatically executed, which prevents the investor from experiencing a larger loss. If a stock is bought at $50 and a stop-loss order is placed at $45, then when the stock price drops to $45 the stop-loss order will be triggered and the stock will be sold.
They can be used to protect profits as well. A stop-loss can be used to lock in gains on a stock that has appreciated in value. For example, if a stock has been bought for $50 and the price rises to $60, a stop-loss order can be placed at $55, which will ensure that the security will be sold if the price drops back to $55.
Stop-Loss orders are also commonly used in conjunction with other types of orders, such as limit and market orders. For example, if a trader wants to buy a stock but doesn’t want to risk more than a certain amount of money, they can place a limit order with a stop-loss order. In this case, the limit order will be executed when the stock reaches a certain price, and the stop-loss order will be triggered if the price falls below a certain level.
They are not guaranteed to limit loss, and they can be triggered even if the stock does not reach the stop price. This is known as a stop-loss order getting “stopped out” and is often due to market volatility or a sudden drop in the stock price.
Stop-Loss orders also have their drawbacks. They can be expensive to execute, and there is also the risk that the stock will not be sold at the stop price if there is a gap in the price. A gap occurs when the stock price suddenly drops or rises significantly, which can cause the stop-loss order to be triggered at a price that is much lower or higher than the stop price.
In summary, a stop-loss order is a type of order placed with a broker or investment firm to sell a security when it reaches a certain price. It is designed to limit an investor’s loss on a security position and can also be used to protect profits. Stop-loss orders can be expensive to execute and are not guaranteed to limit loss, as there is always the risk that the stock will not be sold at the stop price.