What Is a Stop-Loss Order? Definition and Example

Written by Patrick RyanUpdated: 8th Sep 2021
Share this article

Disclaimer: This post contains references to products from one or more of our advertisers. We may receive compensation (at no cost to you) when you click on links to those products. Read our Disclaimer Policy for more information.

Stop-Loss orders allow investors to buy or sell a stock at specific price. Let’s take a closer look at stop-loss orders and detail why every investor should consider utilizing this feature to augment their investing strategy. 

What Is a Stop-Loss Order?

Stop-Loss Orders, which are more commonly known as market orders or stop orders, are trading orders that tell a broker to sell a specific stock, ETF, or mutual fund when it reaches a certain price. Ultimately, hedge-funds, day traders, and everyday investors employ stop-loss orders to mitigate risk and to end a trading position. 

>> Need Help? Read Our Guide on How to Research Stocks

How do Stop-Loss Orders Work?

Stop-loss orders ensure investors can exit a position without suffering a significant loss. If the market tanks or if the stock in question declines, the stop-loss order will be triggered. This order sells the investor’s shares at a specific price in the event of negative news or a massive market-wide downturn. 

What is the difference between stop-loss and stop-limit?

Stop-loss orders are different from stop-limit orders in that they are placed with a broker to purchase or sell a stock when it hits a specific price.

This type of order is meant to reduce the investor’s overall risk and loss. Moreover, stop-loss orders are commonly associated with long-term positions or option trades. 

>> Want Tailored Advice? The Best Stock Picking Services

When Would You Use a Stop-Loss Order?

Stop-loss orders are typically used as a short-term trading strategy. This strategy automatically triggers trades on an investor’s behalf, so they don’t have to follow the market throughout the day.

Whether you are busy with work, family, or an emotional investor who prefers automated trades, then stop-loss orders are worth considering.

Stop-Loss Order Example

Consider a hypothetical scenario in which an investor owns 10 shares of ABC company stock. This investor paid $100 per share.

The investor believes the stock will move to $120 within the next 30 to 60 days. However, if the market goes south, the investor wants protection against a potentially massive loss.

There is also the potential for ABC company to release some unexpected bad news, making the need for a carefully selected exit point that much more important.

The investor instructs their broker to establish a stop-loss order at $80. If the stock rises, the investor reaps the reward. However, if the stock were to fall to $80/share, then the broker will automatically enter the market order to ensure the shares are sold at that specific price.

Once the stop-loss order is triggered, it transitions into a market order, meaning shares are sold at the market rate that might be slightly higher or lower than $80 per share. 

Stop-Loss Orders Pros and Cons

Pros:

  • Automates the sale of a stock when it hits a certain price
  • Improves market liquidity
  • Empowers investors to automate transactions, so they don’t have to watch the market every hour of the day
  • Minimizes investor losses when the price of a stock significantly declines

Cons:

  • If the stock gaps are considerably lower than the stop price, the order is triggered, and the stock is sold for the next available price even if it is below the stop loss order

Are Stop-Loss Orders Hard to Execute?

No. Even if you are new to investing, you will find stop-loss orders are not difficult to execute. There is absolutely no reason to be intimidated by stop-loss orders. Most brokers have detailed guides or customer support representatives who can walk you through the steps to set up a stop-loss order. 

>> Learn More: How to Start Investing

Bottom Line: What Is a Stop-Loss Order?

In short, stop-loss orders allow investors to automatically trigger the sale of a stock when it hits a certain price. Stop-Loss Orders mitigate risk and protect investors from  potentially large losses. 

Keep Reading:

Patrick Ryan
Patrick Ryan

Patrick Ryan is a former SimpleMoneyLyfe authority on investing and personal finance. Patrick graduated from Tulane University with degrees in sociology and political science. He also studied economics at Boston University and Tulane University and holds an ABA-approved paralegal certificate in addition to his undergraduate degrees. Patrick’s areas of expertise are investing, general financial terminology, and financial markets.