A stop loss order – also known simply as a stop order – is designed to protect your capital when an investment moves against you. Set one up and it does the work automatically, closing your position if the price drops to a level you've decided you're no longer comfortable with
Knowing when to sell at a loss is difficult, and not just because the math is complicated – emotions also get in the way. A stop order takes that decision off your plate by automating the trade before things get worse.
It's also the order that you hope never gets triggered. But placing one anyway means you can step away from the trading platform without second-guessing yourself or making an impulsive decision.
How to set a stop price
When you place a stop order, the trading platform will ask for a “stop price.” This is the price at which you'd like to sell if the security falls in value – set it at the point where you're no longer comfortable with owning the investment.
If the price falls to or below the stop price, the stop order triggers and a market order is automatically sent to close your position.
For short positions (where you're betting on a stock falling in value), the logic is reversed. The stop price is set above the current price, triggering a buy order to close the position if the price rises past your exit point.
Why your stop order fill price may differ from your stop price
A stop order is a waiting signal. Once it triggers, it sends a market order to close the position. In the seconds this takes to occur, the market price may have moved above or below the stop price you initially set.
This can happen anytime, including when a stop order is triggered as soon as the market opens. Stop orders can only be triggered during regular market hours, so if bad news breaks overnight and the stock opens well below your stop price, the stop order executes at whatever the opening price is, which could be much lower than your stop price.
Stop orders and bid/ask spreads: what to watch out for
Caution should be used when placing stop orders for securities with large bid/ask spreads. This is typically the case for less traded securities and options.
Because a stop order sends a market order once triggered, it will execute at the best price offered. With these securities, it's usually possible to trade at a price within the bid/ask spread using a limit order, which means you could end up selling at a lower price than you could have. If the alternative is not placing a stop order and struggling to close a falling position due to emotions, it can still be the better choice.
One potential solution to this is to use a stop limit order. Instead of sending a market order, a stop limit order sends a limit order once triggered. The risk is that if your limit price isn't reached, you may hold the position longer than intended.
Stop order duration: day, GTC, and GTD explained
When using a stop order, the price you set may be reached soon, or not at all. Similar to a limit order, you'll need to set a duration to indicate how long the order should remain active.
Most brokerages provide three duration options.
Day: The order remains active until the market closes. If the stop price isn't reached before end of day, the order is automatically cancelled.
Good 'til cancelled (GTC): The order stays open until it fills or is manually cancelled. Most brokerages will automatically cancel GTC orders after 90 days to prevent old orders from being forgotten and unexpectedly executed.
Good 'til date (GTD): You select a specific expiry date. The order is cancelled at the end of the day on that date if it has not been filled.
As a reminder, a stop order is placed not because you want to sell at that price, but because you want to prevent further losses if the price continues to fall.
Can you use a stop order to enter a position?
While commonly used to close positions, a stop order can be used to enter one as well. You'd use this order type when you want a security to prove it has momentum in a certain direction before you commit.
It may seem counterintuitive to the “buy low, sell high” principle, since you're entering at a less favourable price. It does, however, align with strategies that require confirmed price direction before entering.
- Buying: A stop order is placed above the current price. Once the market trades at or above the stop price, a market order is sent to buy.
- Shorting: A stop order is placed below the current price. Once the market trades at or below the stop price, a market order is sent to sell.
Summary
A stop loss order is most commonly used to automatically sell an investment if it falls in value. A price is set below the current price, and this is called the stop price. Best case, the investment rises in value and the stop order is never triggered. Worst case, the price falls to the stop price, the order is triggered, and your position is closed.
