Stop-Loss Order
A stop-loss order is a type of order used by traders to limit their loss or lock in a profit on an existing position. Traders can control their exposure to risk by placing a stop-loss order. Stop-loss orders are orders with instructions to close out a position by buying or selling a security at the market when it reaches a certain price known as the stop price. They are different from stop-limit orders, which are orders to buy or sell at a specific price once the security's price reaches a certain stop price. Stop-limit orders may not get executed whereas a stop-loss order will always be executed (assuming there are buyers and sellers for the security).
For example, a trader may buy a stock and place a stop-loss order with a stop 10% below the stock's purchase price. Should the stock price drop to that 10% level, the stop-loss order is triggered and the stock would be sold at the best available price. Although most investors associate a stop-loss order with a long position, it can also protect a short position. In such a case, the position gets closed out through an offsetting purchase if the security trades at or above a specific price.
Definition: A stop order is a type of order used by traders to limit losses or lock in profits on an existing position. Traders can control their risk exposure by setting stop orders. A stop order is an instruction to close a position by buying or selling a security when its price reaches a specific level known as the stop price. Unlike a stop-limit order, which executes at a specified price when the stop price is reached, a stop order will always execute (assuming there are buyers and sellers for the security).
Origin: The concept of stop orders originated in the early stages of the stock market when traders needed a mechanism to automate risk management. With the development of electronic trading systems, stop orders became more popular and easier to use. By the late 20th and early 21st centuries, with the rise of online trading platforms, stop orders became a standard tool for most traders.
Categories and Characteristics: Stop orders are mainly divided into two categories: stop market orders and stop limit orders.
- Stop Market Order: When the security price reaches the stop price, the order is executed at the current market price. This type of stop order ensures the order will be executed but may be filled at an unfavorable price.
- Stop Limit Order: When the security price reaches the stop price, the order is executed at a preset limit price. This type of stop order may not be executed but ensures the trader will not trade at a price worse than expected.
Specific Cases:
- Case 1: Suppose Investor A buys shares of a company at 100 yuan per share and sets a stop order at 90 yuan. If the stock price drops to 90 yuan, the stop order will trigger and sell the shares at the current market price, limiting Investor A's loss.
- Case 2: Investor B shorts a stock at 50 yuan and sets a stop order at 55 yuan. If the stock price rises to 55 yuan, the stop order will trigger and buy the shares at the current market price, limiting Investor B's loss.
Common Questions:
- Will a stop order always execute? Stop orders typically execute when there is sufficient market liquidity, but slippage may occur under extreme market conditions.
- What is the main difference between a stop order and a stop-limit order? A stop order executes at the market price once triggered, while a stop-limit order executes at a preset limit price and may not be executed.
