What Is a Stop Order?

What Is a Stop Order?

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

A stop order is a type of instruction used in trading securities, such as stocks or futures contracts. It is designed to limit potential loss or lock in a specific profit by “stopping” the trading activity when the price of an asset reaches a certain level. In essence, a stop order directs a broker to buy or sell a security when it reaches a specific price. If that price is achieved, the stop order becomes a market order, which means it is executed at the best available price in the market.

Related Questions

1. How does a stop order differ from a limit order?

A stop order becomes active only after a specific price level is reached. It then convert into a market order to be executed at the best available price. A limit order, on the other hand, is an order to buy or sell a security at a specific price or better. Different from a stop order, it’s not guaranteed to be filled as market prices might not reach your limit levels.

2. What are the advantages of using a stop order?

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Stop orders offer you a certain level of control over the trade execution price. It helps to limit your potential loss, protects profit, and can remove the need for constant market monitoring, as the trade is automatically executed if and when the stock hits your set price.

3. When should I use a stop order?

Stop orders are typically used when you wish to limit your potential losses, or to protect gains on a stock you own. They can be particularly useful when you can’t constantly monitor the price movements of the securities you hold and in times of market volatility.

4. Are there any risks associated with stop orders?

Though stop orders help a lot in managing risk, it’s not free from risks itself. The biggest risk is the order can be executed at a significantly lower/higher price than expected if the market is moving rapidly. This is especially true in volatile markets, or securities with low liquidity.

5. What is the difference between a stop order and a stop limit order?

A stop order turns into a market order once the stop price is reached and the order executes at the best price available. A stop limit order, however, won’t be filled unless the price reaches the specified limit price or better after the stop price has been hit.