Stop Order (Stop-Loss Order)

Definition

The term stop order refers to instructions sent to a broker to buy or sell securities once the security reaches a specified price.  When the price point on a stop order is reached, it is converted to a market order.

Explanation

Also known as a stop-loss order, stop orders are typically used by investors that are not able to closely monitor the movements of their securities.  Since the price specified in the stop order is oftentimes different than the prevailing market price, there is no guarantee the transaction will occur if the price of the security does not pass through the stop price.

Stop orders are oftentimes used in the context of buying or selling shares of stock.  Generally, investors can place this type of order to lock in a profit or prevent a loss:

  • Buy Stop Order:  instructs the broker to convert the order to a market order when the security passes through the stop price.  For example, an investor may place a buy stop order for $32.00 per share when the prevailing market price is $30.00 per share.  This type of order is oftentimes used when an investor has sold a stock short and they want to protect their profit.
  • Sell Stop Order:  instructs the broker to convert the order to a market order when the security passes through the stop price.  For example, an investor may place a sell stop loss order for $28.00 per share when the prevailing market price is $30.00 per share.  This type of order is oftentimes used to protect the profit an investor has earned on a stock in their portfolio.

 
The disadvantage of a stop order is that it does not guarantee execution or price.  Once the security's price passes through the stop price it becomes a market order.   In a volatile market, the price at which the securities are bought or sold may be very different than the stop price.  Limit orders do guarantee the price will be equal to, or better than, the limit price.  As is the case with limit orders, if the price of a security does not reach or pass through the stop price, the sale or purchase of the security will not occur.  For this reason, stop orders are oftentimes combined with instructions that specify their duration.  For example, a stop order may also be a day order or Good-Til-Canceled (GTC).  

Related Terms

All-or-NoneFill-or-Kill, Good-Til-Canceled, Immediate-or-CancelNational Best Offer, National Best Bid, market order, limit order, day order, One-Triggers-the-Other, One-Cancels-All, One-Cancels-the-Other, Good-Til-Date, At-the-Opening