What Is A Stop Order?

What is a stop order? A stop order is a market order to buy or sell a certain quantity of a certain security if a specified price (the stop price) is reached or passed. A stop order is a market order to...

A stop order is a market order to buy or sell a certain quantity of a certain security if a specified price (the stop price) is reached or passed. Once the specified price is reached or passed, your order becomes a basic market order, to be filled immediately by the trader.


Let's take a look at how a stop order works in buying and selling:

Buy stop order: Investors usually use a stop order when buying stock to limit a loss or protect a profit on short sales (a short sale is the sale of a stock you don't own,it is on loan to you from the brokerage firm). The order is entered at a stop price that is always above the current market price.




Sell stop order: A sell stop order helps investors to avoid further losses or protect a profit that exists if a stock price continues to drop. A stop order to sell is always set below the current actual market price.

The benefit of a stop order is that you don't have to consistently monitor how a stock is doing on a daily basis. The downside is that the stop price could be induced by short-term fluctuation in a stock's price. Plus, once your stop price is achieved, your stop order becomes a market order and the price you actually receive may end up being much different from the stop price, especially in a fast-paced market where prices go up and down rapidly. To avoid the risk of a stop order, an investor can place a stop-limit order, which will be discussed on the next page.

Investors like to use stop orders when they leave on vacation or when they enter into a situation that would keep them from monitoring their investments for a period of time. For example, if an investor is expecting a baby she might use stop orders so she doesn't have to worry or think about trading during the tenuous days before and after childbirth.

Traders that employ technical analysis will place stop orders below major moving averages, swing highs, trend lines, swing lows, or other key support or resistance levels.

The use of stop orders is much more common for stocks that trade on an exchange than in the over-the-counter (OTC) market. Additionally, your broker-dealer may not allow to place a stop on some securities or accept a stop for OTC stocks. It would be wise to speak to your financial advisor or someone from the brokerage before entering into these types of orders.

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