What is a Stop Order?

The following text comes from our post “What is the difference in order types“. Check it out for definitions of all the different order types.

 

A stop order is used for buying or selling shares. A buy stop order allows investors to buy only if a security rises to a certain price. A sell stop order allows for investors to set up a way to limit losses on a particular security by automatically selling at a certain price.

 

Buy Stop Order

A buy stop order triggers a market order to buy once a certain price is achieved.

For example, an investor may be interested in a particular stock whose shares are declining, but they are worried about buying now and having the share price continue to decline.

Using the example above, let’s say an investor wants to buy shares of the security, but only if it goes above $83.00 per share. In this case, and investor could set a Buy Stop Order at $83.00.

Once the share price reaches $83.00 (or any price above $83.00), a buy market order is executed.

 

For a buy stop order – always set the stop price at or above the current market price.

 

Sell Stop Order

 

A sell stop order is submitted AFTER you have already purchased shares of a particular security.

Let’s say you purchase the selected security shown above for $82.41 per share, but you are worried the share price may drop and you can’t handle the potential losses. You can set a Sell Stop Order to automatically sell your shares at a lower price if that price is reached.

For example, if you want to have your shares sold if the security reaches $81.00, you would submit a sell stop order at $81.00.

If the shares never decline down to $81.00 you will continue to hold your shares.

 

For a sell stop order—always set the stop price below the current market price.

 

But be warned, there are several situations where your stop order may not execute at the price you had set. In fact it is possible for the price to execute much lower (for a sell stop order) or much higher (for a buy stop order)!

  •   In times of terrible news or events, the price of the security may drop significantly very fast. If this occurs, there may be no investors willing to purchase the shares at your stop price. In this case, your stop order will execute at the next available price. If the price per share drops instantly to $80.00, even if you have a sell stop order at $81.00, you will sell your shares for $80.00.

 

  •   The same thing can happen under a buy stop order if the price of a security gaps up significantly. If your buy stop order is at $83.00, but the share price gaps up to $85.00, you will purchase the shares at $85.00.

 

Effectively what happens is when your Stop price (or anything above or below it depending on if it is a buy or sell order) is reached, a market buy/sell order is triggered. Recall our definition above of a market order – this means that you buy/sell at the best available price. A stop order is not a guarantee to buy or sell at that price!