What is a stop loss order?

A stop loss order is a tactic to that you can use to minimize your risk after purchasing stock. You may not purchase insurance to protect your stock investment from loss. The government will protect it against theft, but not from depreciation in value. A stop loss order will help protect your stock investment from going too low. This decreases your risk.

Some people confuse a stop loss order from a limit order and a short sale. All are tactics for stock transactions. You may want to understand each type of transaction to better understand what a stop loss is.

Buy Limit or Limit Order
A buy limit order is useful for preventing you from overpaying for a fast-moving stock. For instance, if you want to purchase XYZ and the last time you looked the stock was trading at $25 per share then you could place a maximum limit on the amount you are willing to pay. If you limit the order at $27, then your stock broker will only execute the purchase if he can find a seller that is willing to sell the shares below $27.

Usually a limit order will have an expiration date. This prevents the order from being valid for too long and executing when you don't want it to. For example, if your limit order is valid for six months, the company could have some terrible news and declare bankruptcy. If you limit order is still valid, you may end up purchasing some stock when the price comes down when the stock market hears the bankruptcy news.

Short Sale
A short sale is an order to sell a stock that you don't own. Short-selling involves borrowing shares from your broker and selling those borrowed shares in the hope that the price will drop. You will be able to replace the borrowed shares by buying them at the lower price. Selling short requires that you have a margin (credit) account with your broker. This tactic can be very risky because you can lose more money than you have put into the market. Only the sophisticated investor should be using this tactic.

Stop Loss Order
A stop loss order is used only after the stock has been purchased. You put a stop loss order on the stock you own to protect it from going too low. This is a way to keep your investment from shrinking too small. Another way to say it would be to limit your risks or even a type of insurance.

A sell stop is an order to sell a stock if it drops below a specified price. If you purchase a stock at $25, you can put a sell stop at $20 so that if the price drops to that point, your broker will automatically sell in order to limit your losses. However, the stop loss order won't guarantee you will get that price. For example, if bad news hit the company during the night when the exchange is closed, the stock might open the following morning at $18. Your sell stop limit would be triggered so your stock would sell, but you would only get $18 per share.

You can now see the different types of ways you can purchase stock. The stop loss order should be used to minimize your risk after placing a purchase order.

In summary, a stop loss order will help protect your stock investment. It will keep your stock from going too low by automatically selling when a designated price is reached on the open market. However, you are not guaranteed a price and it may be sold for less than the stop loss order.

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Categories: Buying and Selling Stocks,

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