Stop-Loss Order

Stop-Loss Order

A stop-loss order is an instruction to your broker to buy or sell a security once its price reaches a specified level (the stop price). When the stop price is hit, the stop-loss becomes a market order and is executed at the next available price. Traders and investors use stop-loss orders to limit losses, protect profits, and reduce the need to monitor positions constantly.

Key takeaways

• A stop-loss order automatically exits a position when a security reaches a preset price, helping limit losses.
• Unlike a stop-limit order, a stop-loss converts to a market order on trigger and generally guarantees execution (subject to market liquidity).
• Execution price can differ from the stop price in fast or gapping markets.
• Trailing stops adjust the stop price as the market moves in your favor, helping lock in gains.

How stop-loss orders work

• Sell stop-loss: placed below the current price; triggers a market sell order when the price falls to or below the stop.
• Buy stop-loss: placed above the current price; used to limit losses on short positions or to enter a position if price breaks out.
• Once triggered, the stop-loss becomes a market order and executes at the best available price, which may be above or below the stop price depending on market conditions.

Stop-loss vs. stop-limit

• Stop-loss (stop-market): guarantees execution once triggered but not the execution price.
• Stop-limit: becomes a limit order at the limit price when the stop is reached; execution is only at the limit price or better and may not occur if the market moves past the limit.
  Choose stop-loss when execution certainty matters; choose stop-limit when control over execution price is more important than guaranteed fill.

Advantages

• Limits downside risk without constant monitoring.
• Helps remove emotion from trading decisions.
• Can preserve gains when combined with trailing stops.
• Simple to implement across most brokerage platforms.

Risks and disadvantages

• Price gaps: if the market gaps past the stop, execution can occur far from the stop price, increasing losses.
• False triggers: volatile or choppy markets may trigger stops on temporary moves, closing positions that soon recover.
• Market-order execution risk: during low liquidity, fills can be at worse prices than expected.

Trailing stops

A trailing stop moves the stop price by a fixed amount or percentage as the security’s price moves in your favor. It allows you to:
* Lock in profits by raising the stop on long positions as price rises.
* Maintain downside protection without manually resetting the stop.
Trailing stops convert to market orders when the trailing level is breached.

Examples

• Example 1 — Protecting capital: Buy 100 shares at $100, place a stop-loss at $90. If the price falls to $90, the order triggers and the shares sell at the next available price, limiting further loss.
• Example 2 — Gap risk: Buy 500 shares at $100 with a stop at $90. After adverse overnight news, the market opens at $50. The stop triggers, but the execution occurs near the open price, resulting in a much larger loss than $10 per share.

Practical tips for setting stops

• Use a percentage or dollar amount based on your risk tolerance (e.g., 5–15% for many traders).
• Consider technical levels (support/resistance, moving averages, volatility bands) rather than arbitrary numbers.
• Avoid placing stops too tight in volatile stocks to reduce false triggers.
• Reassess stop levels after major events, earnings, or structural changes in the trade thesis.

Long-term investors and stop-losses

Long-term investors typically tolerate short-term volatility and may not need stop-loss orders. Stops can produce unnecessary trades during normal market swings. Instead, long-term investors should:
* Focus on fundamentals and portfolio diversification.
* Reevaluate positions after meaningful changes in business prospects or permanent capital impairment.

Quick FAQs

Q: Will a stop-loss always protect me from big losses?
A: No. Stop-losses help limit losses but cannot guarantee a specific exit price during gaps or low-liquidity periods.

Q: Should I use stop-losses on every trade?
A: For active traders and short-to-medium term positions, stops are a valuable risk-control tool. Long-term investors may prefer strategy-based evaluation over automatic stops.

Q: Are trailing stops better than fixed stops?
A: Trailing stops are useful to lock in gains while allowing upside, but they can still be stopped out by temporary pullbacks. Choose based on trade objectives.

Conclusion

Stop-loss orders are a simple, effective risk-management tool that can limit downside and automate exits. Understand their mechanics, risks (especially gap risk), and how they compare with stop-limit orders. Use sensible placement tied to risk tolerance and market structure, and consider trailing stops to protect profits while letting winners run.