Business, Legal & Accounting Glossary
A stop order is an order to automatically liquidate a stock position when the stock’s price reaches a certain point. A stop order liquidates a position at the best price possible once the target price has been touched. A stop order can be used to either lock in profits or to minimize a loss. Many investors place their stop order as a trailing stop in order to take advantage of a favourable market trend for as long as possible. For example, an investor who is long XYZ Corporation at $10.00 per share might place a trailing stop order 5% (or 50 cents) below the current market price. If the price per share drops 5% the stop order automatically liquidates the position, limiting the investor’s losses. If the market starts up, the trailing stop order follows the stock, always remaining 5% below the stock’s highest price. When the stock ultimately drops 5% below its highest price the stop order automatically liquidates the position, locking in a profit. A stop order is an important tool for managing risk.
A stop order is a speciality brokerage order that triggers an action when the stock hits a specified price.
For example, if you bought a stock at $10 that’s now trading at $20 and you want to “protect” some of your gains, you can place a sell stop order with your broker at say $18. If the stock price drops to $18, a simple sell stop order will trigger an immediate market sale, which means you’ll get the price of the next available shares. It should be noted that a simple sell stop order does not guarantee a price of $18 on your sale, but it does guarantee execution.
When triggered, a stop order becomes a market order.
Many investment advisers and long-time investors preach against these. In setting automated actions based on pricing, the long-term investor is allowing the market to dictate the price at which one winds up selling. Many times, corporate events pop up and surprise the market and kick people out of long-term positions based on their stop orders.
Market volatility will often trigger a stop order soon after it is placed. In an age of discount broker commissions, repurchasing the position after a false sale event is not costly, but the Wash Sale Rule can be a limit in the case of a loss. To avoid premature triggers, an email or text alerting service can be preferable–allowing you a decision on whether to sell or wait out the event.
Also, for stop losses, many investors operate under a misconception that they’ll save themselves from significant stock drops. But if you have a stop order at $15 for a stock that closed yesterday at $20, reports bad news, and opens at $12 — you will sell at $12, not at $15.
Just know that if you’re going to use stop orders, you are taking your own decision-making out of the game and setting an automated direction based on ephemeral — sometimes irrational — price movements.
Market order
Stop limit order
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This glossary post was last updated: 28th November, 2021 | 0 Views.