What Is a Stop-Loss Order?

What Is a Stop-Loss Order?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

A stop-loss order is a type of advanced trade you can place with your broker. This order is designed to limit an investor’s loss on a position in a security. Essentially, when you place a stop-loss order, you’re telling your broker to sell a security when it reaches a specific price.

For instance, let’s say you’ve bought a stock at $50 per share. Now, you want to limit your loss to no more than 10%. You’d place a stop-loss order at $45 (which is 10% below $50). If the stock price drops below $45, your stop-loss order would be activated and the stock sold.

It’s a smart strategy to manage your investment risk.

Related Questions

1. How does a stop-loss order work?

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When you set a stop-loss order, you’re predetermining your exit point. If the security drops to your stop price, the order will be activated, and the security will be sold at the best possible price. Such orders are designed to limit your loss and to protect gains on an investment.

2. What’s the difference between a stop-loss order and a limit order?

A stop-loss order tells the broker to sell a security once it reaches a specific price, whereas a limit order is a directive to sell or buy a security at a specified price or better. So, a limit order guarantees the price but not the execution, while a stop-loss order guarantees the execution but not the price.

3. Can stop-loss orders be used for buying?

Yes, stop-loss orders can also be used for buying securities. It’s known as a “buy stop order” and is typically used to limit a loss or to protect a gain on a security that was short-sold.

4. What are the drawbacks of using a stop-loss order?

Even though stop-loss orders can be very useful, they’re not without risks. The biggest risk is that the stop price could be activated by a short-term fluctuation in a security’s price. Once your stop price is breached, the stop-loss order becomes a market order, which means there’s no guarantee on the price you’ll receive.

5. Can I use stop-loss orders with all types of investments?

You can use stop-loss orders for most stock and option trades, but they’re not available for some mutual funds and bonds. Always check with your broker before placing these types of trades.