What is stop-loss order?
A stop-loss order is a predefined advance order to buy in or sell off securities or assets when reaching a particular price. It is often an automated order that investors place with their broker/agent and, in turn, pay a certain amount of brokerage. A broker/agent who has received a stop-loss order sells a security/asset when it reaches a pre-set price limit. The purpose of placing such an order is to limit loss or gain from trade. The concept is used in short-term and long-term trading. Other names for stop-loss orders are a ‘stop order’ or sometimes a ‘stop-market order’.Highlights
Frequently Asked Questions (FAQ)
How does stop-loss order work?
A stop-loss order mentions the highest price for a security at which the investor wants to buy it or the lowest he wants to sell. An investor places a stop-loss order to cut losses at a given current market price. When received by a trading company or broker, he records the price limit set and takes action accordingly. Generally, the order is automated at the price level. It is often a tool used for short-term investment planning or to monitor pressure changes in a security price daily.
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Example of a stop-loss order
Suppose an investor Fish buys a stock at USD100 and thinks that he cannot bear more than USD95. So, Fish can place a stop-loss order with his brokerage to sell the stock if it reaches USD95. Once this order is placed, Fish can rest assured that his asset will not generate a loss of more than USD5 risk.
What purpose does stop-loss order fulfill?
Stop-loss orders are targeted towards the reduction of risk exposure and show utility by limiting potential losses. In addition, such orders make trading easier as an automated order is already in place that can be executed if the market trades at a pre-set price.
Traders are strongly urged always to use stop-loss orders to limit their risk and avoid a potentially catastrophic loss whenever they enter a trade. Stop-loss orders make trading less risky by limiting traders’ capital risked on a single trade.
Using a stop-loss order, individuals can manage their losses effectively without monitoring the market daily and closely. As a result, it is particularly beneficial for risk-averse individuals aiming to make substantial profits through stock market investments while minimising the exposure to market fluctuations.
It also helps traders and investors exit a position before it reaches an un-perceived highest or lowest value.
What are the pros and cons of stop-loss order?
A stop-loss order has the following advantages-
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Few disadvantages of stop-loss orders are-
How stop loss differs from limit order?
A limit order is executed when security is saleable or purchased at a specified price or for better. A buy limit order facilitates purchase when the security price falls below a pre-set limit. A sell limit order gets triggered when the security price rises over a pre-set value. These orders enable investors to maximize profitability by widening the bid-ask spread.
However, a stop-loss order is triggered only when the price is equal to a predetermined price, being used by investors for minimizing losses, usually in a bear market. If the price level of security goes beyond the stop-loss order price, it gets converted into a market order to buy or sell at the best available prices. Thus, there are chances it may not get filled at the exact specified stop price level.