Stop Loss Order: How It Works, Pros and Cons, Examples


An investor comparing the benefits and drawbacks of using stop loss orders.
An investor comparing the benefits and drawbacks of using stop loss orders.

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A stop loss order is a trading tool that automatically sells a security if its price falls to a set level, helping investors limit losses without constantly monitoring the market. While it can protect against sudden drops, execution prices may vary in fast-moving markets. Different types of stop loss orders provide varying control over trade execution, allowing investors to adjust their strategies based on risk and market conditions. A financial advisor can help determine how to use a stop loss strategy based on your portfolio.

A stop loss order is a type of stock order or trading instruction that automatically sells a security when its price reaches a predetermined level. Investors and traders use stop loss orders to limit potential losses without the need for constant monitoring. These orders are placed through a brokerage and remain active until the stop price is triggered or the investor cancels the order.

Stop loss orders are particularly common in volatile markets, when prices can change quickly. By setting a stop price, traders establish a threshold where they are willing to exit a position. This type of stock order helps automate risk management and reduce the emotional aspect of decision-making that can cause traders to stray from their preset strategy.

When an investor places a stop loss order, the broker converts the order into a market order once the security reaches the designated stop price. A market order instructs the brokerage to sell the asset at the best available price. This price may differ from the stop price in fast-moving markets.

For example, if a trader buys a stock at $50 and sets a stop loss order at $45, the stock will be automatically sold if its price drops to $45 or lower. If the stock declines sharply, the execution price could be lower than $45 due to market fluctuations. This difference between stop price and execution price is known as slippage.

A financial advisor explaining different types of stop loss orders to clients.
A financial advisor explaining different types of stop loss orders to clients.

You can use different types of stop loss orders, depending on your investment strategy. Some provide simple sell triggers, while others offer more flexibility in execution. Here are three common ones to consider:

  • Standard stop loss order. A basic stop loss order converts to a market order when the price reaches the specified level. This ensures execution but does not guarantee a specific selling price. For example, if an investor buys a stock at $75 and places a stop loss at $70, the stock will be sold once it reaches that level, though the final execution price could be lower.

  • Trailing stop loss order. A trailing stop loss order adjusts dynamically as the price moves in the investor’s favor. Instead of setting a fixed stop price, the stop price follows the stock at a fixed percentage or dollar amount. For example, a 5% trailing stop loss on a stock purchased at $100 would initially place the stop price at $95. If the stock rises to $110, the stop price moves up to $104.50, which is 5% below $110. If the price declines from there, the stop order is triggered at $104.50.

  • Stop limit order. A stop limit order is not, strictly speaking, a type of stop loss order, but functions somewhat similarly and can also be used for risk management. The difference is that, instead of converting to a market order, it converts to a limit order at the specified price. This prevents selling at a price lower than the investor’s specific limit price. Unlike a stop loss order, it carries the risk of the order not being executed at all if the price moves too quickly. For example, if an investor purchases shares at $40 and sets a stop price at $35 with a limit at $34, the stock will only sell at $34 or higher, potentially leaving the investor with an unfilled order if prices drop too fast.



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