Stop order

Quick definition

An instruction from a customer that gives a stockbroker instructions to execute an order once an asset price hits a certain level.

Key details

• Stop orders instruct your broker to execute an order at a certain price point
• The most common type of stop order is a stop-loss
• Stop-loss orders limit your downside during periods of high volatility

What is a stop order

A stop order is an instruction to execute a market order at a particular price. Usually it’s used to limit your losses by instructing a broker to sell a security when the price falls below a certain level. That is generally referred to as a ‘stop-loss’ order.

A stop-loss or sell stop order sets a kind of floor for the price of the security. If the price hits that floor and goes past it, the position automatically triggers a market order. In simple terms, if your stock goes below a certain price, your broker will sell it immediately to protect your financial position. 

On the other hand, the buy stop order sets a ceiling in that a trader locks in profits before the stock takes a turn for the loss. In simple terms, if your stock reaches a certain value, your broker will try and sell it immediately to lock in your win.

For example, consider a trader who owns a certain amount of shares belonging to company WXY. To protect the position from loss, the trader sets $20 as the sell stop order. If the price of WXY’s stock reaches $20, the position threatens to become unprofitable, and it automatically becomes a market order.

However, this works differently for a profitable position. Say the trader sets $50 as the buy stop order. Specifically, the trader intends to take a profit once the price of WXY’s stock hits $50. As such, the trader will enjoy profits in case the price turns on its head and slides to under $50.

These are vital trades that help you manoeuvre the stock market, if you can’t monitor the stock market 24 hours per day, then you need to have these in place.

Types of stop-loss orders

There different kinds of stop-loss orders available to traders. These are:

• Regular stop order – This is an order that instructs the broker to execute a market order the moment it hits a certain stop price. However, a fast-moving market might not allow the execution to happen at the stop price. As such, the trader is at risk of suffering substantial slippage.
• Stop limit order – This is a sophisticated form of stop-loss order that aims to cure the problems of the regular stop-loss order. This order entails the trader setting two stop prices, one for stop order and the other for limit order. While there is a guarantee of order execution with a regular stop order, the process might execute at a far worse price than desired. As such, the limit order offers insurance against such an occurrence since it guarantees a price limit.
• Trailing stop order – Here, the trader does not set a specific stop price. Instead, he/she relies on the percentage change in the prevailing market price. If the market price declines below a certain target percentage, the position automatically converts to a market order. This is preferred by those who are simply looking to avoid volatility.