A stop order is an order to buy or sell a stock once it reaches a certain price, known as the stop price. A stop order instructs your broker to execute a trade if the stock price moves against you, limiting your losses.
Stop orders are a great way to protect your profits and limit your downside risk. You place a safety net underneath your trade when you enter a stop order. If the stock price falls below your stop price, your broker will automatically sell your shares, minimising your losses. Stop orders come in two types: buy-stop orders and sell-stop orders. When the Stop price is hit, the Stop Order becomes a Market Order and then executes at the best current price available at the time.
What is a Stop 'Buy' order in Invest/ISA?
A buy-stop order is used to buy a stock once it reaches a certain price. For example, if you want to buy a stock that is currently trading at $50, but you only want to buy it if it goes above $55, you would enter a buy-stop order with a stop price of $55. If the stock reaches $55, your broker will automatically execute the trade, buying the stock at the best available price.
Here's how to set one:
- Select an instrument;
- Choose the number of shares to Buy;
- Set a Stop Price above the current one which you're willing to pay for a share;
- Review the order and confirm.
What is a Stop 'Sell' order in Invest/ISA?
On the other hand, a sell-stop order is used to sell a stock once it reaches a specific price. For example, if you own a stock currently trading at $50 but want to limit your losses if the stock drops below $45, you would enter a sell-stop order with a stop price of $45. If the stock reaches $45, your broker will automatically execute the trade, selling the stock at the best available price.
Here's how to set one:
- Select the instrument you'd like to sell shares of;
- Set the number of shares to Sell;
- Set a Stop Price below the current one which you're willing to sell your shares;
- Review the order and confirm.
Note: A Stop Order will remain pending, and the funds needed for its execution - blocked, until its target price is reached. It cannot be modified unless cancelled and replaced by a new order of the same or a different type.
Pros of stop order
One of the main pros of stop orders is their effectiveness in risk management. By setting a stop price, traders can ensure that their positions are automatically sold if the stock price falls below a certain level. This can help prevent significant losses in the event of a sudden market downturn. In addition, stop orders are flexible. They can be customised to suit a trader's specific needs. For example, traders can set different stop prices for different positions, depending on the level of risk they are comfortable with. Additionally, stop orders can be adjusted in real-time, allowing traders to react quickly to changing market conditions.
Cons of stop order
The main cons of stop orders are that they may not execute as intended during periods of market volatility. In fast-moving markets, prices can fluctuate rapidly, causing stop orders to be executed at prices far below their intended level. This can result in significant losses for traders expecting to limit their losses with a stop order.
Stop orders and price gaps: How do price gaps influence stop orders?
Stop orders can be affected by price gaps in the market. A price gap occurs when there is a significant difference between the closing price of a security and the opening price of the same security on the next trading day. A price gap can cause a stop order to be executed at a price significantly different from the stop price specified by the trader. This can happen because stop orders are triggered when the market price of a security reaches or crosses the stop price determined by the trader. If the market price gaps through the stop price, the stop order may be executed at a price far from the intended price. For example, a trader places a sell-stop order on a stock at a stop price of $50. However, the news is released overnight that caused the stock to gap down to $40 at the market opening. Suppose the trader's stop order is triggered at the market opening. In that case, the order may be executed much lower than the intended stop price of $50.