STOP ORDER | STOP-LOSS ORDER

A stop order is a type of contingent order because the order does not get executed unless the market price first reaches a certain point, in this case, the stop price. You will use a stop order to instruct your broker to sell if prices fall to a certain point (the stop price), or to buy if prices rally to a certain point (the stop price). Consequently, a stop order to sell has a price that is below the market price while a stop order to buy has a price that is above the market price.

A stop order can be used to establish a new position or to close an existing or open position and there is usually no distinction made between the two among brokers or on most trading platforms.

Establishing a New Position

A stop order can be used to establish a new position and it is typically used in this manner to trade a price break-out from an established trading range. For example, let's say that a market has been range trading between a low of 80 and a high of 100. If prices fall through support at 80 and reach say, 75, then you believe that prices will continue to fall and you desire to short or sell the market. To be prepared should this happen, you would enter a stop order to sell at 75. On the other hand, should the market break through resistance at 100 and reach say, 105, then you believe that prices will continue to rally and you desire to go long or buy the market. To be prepared should this happen, you would enter a stop order to buy at 105. At what price below support or above resistance the stop price should be set will depend upon the rules of your trading system. (For more information on break-out trading, see Support and Resistance.)

Closing an Open Position

A stop order is more commonly used to automatically close an open position should the market move adversely and this is regarded by many traders as being a stop-loss order or protective stop order. The stop order can be used in this manner to limit loss on a position to a prescribed amount and, as such, the stop order becomes a useful risk management tool. This amount to risk on a position before it is closed will depend upon the rules of your trading system. Should the market move favorably, the trader can consider trailing the stop order to lock-in profits accrued but not yet unrealized. (See Trailing Stop Order.)

Slippage on Stop Orders

Stop orders are often filled with some slippage meaning that the fill price can be worse than the stop price. When a stop order is used to close an open position, slippage means that loss on a trade will be a little more than you expected, or that profit will be a little less. Every trader must accept this fundamental limitation of the stop order. Slippage can become large if a market is very volatile and moves suddenly, or if the market opens at a price significantly different from the prior day's closing price. In other words, the market price "gaps" on the open. While this type of activity can occur at virtually any time, you can protect yourself a little by confining your trading to relatively less risky markets. You can also consider using a stop-limit order. (See Stop-Limit Order.)

• The basics of the stop order
• Using the stop order to protect a long position
• Using the stop order to protect a short position
• Day vs Good-Till-Canceled stop order
• Risks or short-comings of stop orders

Mechanics of a Stop Order

A stop order to buy has a price, the stop price, set above the current market price and becomes active should the market trade at the stop price. The buy stop order may be filled at a price that is higher than the stop price and this is called slippage. A stop order to sell has a price, the stop price, set below the current market price and becomes active should the market trade at the stop price. Here again, because of slippage, the sell stop order may be filled at a price that is lower than the stop price.