Stop Loss Order / Stop Order

What is a stop loss order, also known as a stop order?

This is an order that becomes a market order when a particular price level is reached. A sell stop is placed below the market, a buy stop is placed above the market. (Source: CFTC)

A stop order is an order to buy or sell a stock once the price of the stock reaches a specified price, known as the stop price. When the specified price is reached, your stop order becomes a market order.

Buy Stop Order — Investors typically use a stop order when buying stock to limit a loss or protect a profit on short sales. 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 to protect a profit that exists if a stock price continues to drop. A stop order to sell is always placed below the current market price.

The advantage of a stop order is you don't have to monitor how a stock is performing on a daily basis. The disadvantage is that the stop price could be activated by a short-term fluctuation in a stock's price. Also, once your stop price is reached, your stop order becomes a market order and the price you receive may be much different from the stop price, especially in a fast-moving market where stock prices can change rapidly. An investor can avoid the risk of a stop order not guaranteeing a specific price by placing a stop-limit order.

The use of stop orders is much more frequent for stocks that trade on an exchange than in the over-counter (OTC) market. In addition, your broker-dealer may not allow you to place a stop order on some securities or accept a stop order for OTC stocks. Before you enter into these types of orders, you should speak to your broker or financial advisor about how these orders work. (Source: SEC)

A stop order (sometimes known as a stop loss order) is the complement of a limit order. It is an order to buy (or sell) a security once the price of the security climbed above (or dropped below) a specified price, known as the stop price. When the specified price is reached, the stop order is entered as a market order. The difference between stop order and limit is that in the former, a desired selling price (ask) will always be below the current price. Similarly, in stop order a desired buying price (bid) will always be above the current price. However, in limit orders, the ask will be above current price and the bid will be below current price. Hence, stop order is the complement of limit.

A sell stop order is an instruction to sell at the best available price after the price goes below the stop price. A sell stop price is always below the current market price. For example, if an investor holds a stock currently valued at $50 and is worried that the value may drop, he/she can place a sell stop order with the broker at $40. If the share price drops to $40 for whatever reason, the broker will sell the stock at the next available price. This can limit the investor's losses (if the stop price is at or below the purchase price) or lock in at least some of the investor's profits (if the value of the security has risen between when the security was purchased and the stop order placed).

A buy stop order is typically used to limit a loss (or to protect an existing profit) on a short sale. A buy stop price is always above the current market price. For example, if an investor sells a stock short (borrows stock and sells it immediately at current market price (Shorting), and the investor hopes the stock price goes down in order to give the borrowed shares back at a lower price (Covering) while pocketing the difference), the investor may try to protect himself against losses if the price goes too high using a buy stop order.

With a stop order, the customer does not have to actively monitor how a stock is performing. However because the order is triggered automatically when the stop price is reached, the stop price could be activated by a short-term fluctuation in a security's price. Once the stop price is reached, the stop order becomes a market order. In a fast-moving market, the price at which the trade is executed may be much different from the stop price. The use of stop orders is much more frequent for stocks, and futures, that trade on an exchange than in the over-the-counter (OTC) market. (Source: Wikipedia)

See also:
Stop-Losses Blog Posts

Stop Limit Order

What is a stop limit order?

A stop limit order is an order that goes into force as soon as there is a trade at the specified price. The order, however, can only be filled at the stop limit price or better. (Source: CFTC)

A stop-limit order is an order to buy or sell a stock that combines the features of a stop order and a limit order. Once the stop price is reached, the stop-limit order becomes a limit order to buy or to sell at a specified price.

The benefit of a stop-limit order is that the investor can control the price at which the trade will get executed. But, as with all limit orders, a stop-limit order may never get filled if the stock's price never reaches the specified limit price. This may happen especially in fast-moving markets where prices fluctuate wildly.

The use of stop limit orders is much more frequent for stocks that trade on an exchange than in the over-counter (OTC) market. In addition, your broker-dealer may not allow you to place a stop limit order on some securities or accept a stop limit order for OTC stocks. Before you enter into this type of order, you should speak to your broker or financial advisor about how the order works. (Source: SEC)

Market Order

What is a market order?

A market order is an order to buy or sell a futures contract at whatever price is obtainable at the time it is entered in the ring, pit, or other trading platform. (Source: CFTC)

A market order is an order to buy or sell a stock at the current market price. Unless you specify otherwise, your broker will enter your order as a market order.

The advantage of a market order is you are almost always guaranteed your order will be executed (as long as there are willing buyers and sellers). Depending on your firm’s commission structure, a market order may also be less expensive than a limit order.

The disadvantage is the price you pay when your order is executed may not always be the price you obtained from a real-time quote service or were quoted by your broker. This may be especially true in fast-moving markets where stock prices are more volatile. When you place an order "at the market," particularly for a large number of shares, there is a greater chance you will receive different prices for parts of the order. (Source: SEC)

A market order is a buy or sell order to be executed by the broker immediately at current market prices. As long as there are willing sellers and buyers, a market order will be filled.

A market order is the simplest of the order types. Once the order is placed, the customer has no control over the price at which the transaction is executed. The broker is merely supposed to find the best price available at that time. In fast-moving markets, the price paid or received may be quite different from the last price quoted before the order was entered.

A market order for a large number of shares may be split by the broker across multiple participants on the other side of the transaction, resulting in different prices for some of the shares. (Source: Wikipedia)

Limit Order

What is a limit order?

An order in which the customer specifies a minimum sale price or maximum purchase price, as contrasted with a market order, which implies that the order should be filled as soon as possible at the market price. (Source: CFTC)

A limit order is an order to buy or sell a security at a specific price. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher. When you place a market order, you can't control the price at which your order will be filled.

For example, if you want to buy the stock of a "hot" IPO that was initially offered at $9, but don't want to end up paying more than $20 for the stock, you can place a limit order to buy the stock at any price up to $20. By entering a limit order rather than a market order, you will not be caught buying the stock at $90 and then suffering immediate losses if the stock drops later in the day or the weeks ahead.

Remember that your limit order may never be executed because the market price may quickly surpass your limit before your order can be filled. But by using a limit order you also protect yourself from buying the stock at too high a price. Some firms may charge you more for executing a limit order than a market order. (Source: SEC)

A limit order is an order to buy a security at no more (or sell at no less) than a specific price. This gives the customer some control over the price at which the trade is executed, but may prevent the order from being executed ("filled").

A buy limit order can only be executed by the broker at the limit price or lower. For example, if an investor wants to buy a stock but doesn't want to end up paying more than $20 for the stock, the investor can place a limit order to buy the stock at any price up to $20. By entering a limit order rather than a market order, the investor will not be caught buying the stock at $30 if the price rises sharply.

A sell limit order can only be executed at the limit price or higher.

A limit order may never be executed if the market price surpasses the limit before the order can be filled. Because of the added complexity, some brokerages will charge more for executing a limit order than they would for a market order. (Source: Wikipedia)

See also:
Limit Order Blog Posts