What Is a Stop Order?
Stop orders, also known as stop-loss orders, are one of the two main types of orders you'll encounter in the market: stop and limit. The point of a stop order is that it always executes in the direction the price is moving. For example, if the market is moving lower, a stop or stop-loss order will sell at a pre-set price lower than the current market price. Alternatively, if the price moves higher, a stop order will buy if the security hits a specific price. Once the price reaches that level, the stop-buy order becomes a limit order or a market order, and can be traded at the next available price.
How do stop orders work?
An investor can use stop orders when buying or selling securities such as stocks. When placing a stop order, you need to set a stop-loss price. If this price is reached, the order will be triggered at the next best price on the market.
If the stop-loss price is not achieved, the price at which the order is executed may differ from the actual stop-loss price. There can be numerous shifts in a fast-moving market. Depending on the market circumstances at the time of the transaction, you may acquire at a more excellent price and sell at a lower price.
The pros and cons of stop orders
As with any order for your investment, consider the pros and cons before placing a stop order.
Advantages:
Buy or sell stop orders can be used
Provide precise control
Can be used to limit losses and ensure profits
Disadvantages:
Orders may not be executed
You may end up paying more
May be sold at a loss due to price volatility
Quick Tip: Because every brokerage has a different definition of when the stop price is reached, find out how your brokerage determines the price that triggers the stop order.
Stop Orders vs. Stop-Limit Orders vs. Market Orders
Depending on your position and overall market strategy, several stop orders can be used to gain control over your trades. A stop order is just one type of them.
A stop order has a price that triggers a buy or sell order. When the stop-loss price is reached, the order is activated and turned into a market order, which can be traded immediately. A buy-stop order can be placed above the current market price, and a sell-stop order can be set below the current market price. These orders are used by investors to restrict their losses and to ensure their gains on investment.
A stop-limit order is similar to stop-loss orders in that they are price-triggered to execute buy or sell orders. The main difference is that the order must be at a limited price or better. For example, if you wish to buy a stock for $50, you may set $50 as your limit price, and the order will only happen when the price of the stock you want hits $50 or lower.
A market order is an order type to sell or buy securities instantly. A stop or limit order must reach a specific price to execute, but a market order will execute anyway. This type of order guarantees the order to go through but does not guarantee that you get a specific price.
A stop-loss order is similar to a stop-limit order in that it is price-activated; A limit order, on the other hand, provides you with more control over your expenses. When there is a lot of price volatility, this might be favorable.
Quick Tip: Depending on your buy-stop order or sell-stop order, you may pay more in commissions for your various trades. Be sure to research the cost ahead of time and consider it.
Conclusion
Having more control over your assets may be beneficial, and stop orders help to optimize that control. However, if your order does not reach the stop loss price, it may not be executed due to the stock market volatility.
Stop orders are not always triggered. While they can avoid big losses under normal market conditions, they are by no means invulnerable. Extremely low liquidity and market lock-ups are examples of when a stop order may be useless to you.
Furthermore, if the stop price is reached, your transaction will be executed at the following available pricing, which might be higher or lower than you set. You may also consider using a stop-limit order to limit costs further, and you should also be aware that commission costs may increase with various transactions.