A stop order is an instruction by which an investor orders a broker to buy or sell securities on their behalf if the price of those securities or their underlying assets falls below or above a certain threshold.
A stop buy order (also known as a stop entry order) is used to trigger a purchase of securities when their price reaches a predetermined stop buy limit. A stop loss order (also known as a stop sell order) is used to trigger a sale of securities when their price decreases to a predetermined stop loss limit.
When the stop threshold is reached, the order is converted to a market order. In a market order, orders are filled at the best offer (when you buy) or the best bid (when you sell). That means you may pay more than the stop entry threshold for the purchase of assets, and you may get less than the stop loss threshold for the sale of assets because the best available bids and offers may be better or worse than the stop threshold.
Example of a stop entry order: You want to buy 200 shares in a certain stock, but you do not want to pay more than 110 Swiss francs per share. The current market price of the stock is 113 francs per share. You place a stop entry order with your broker instructing them to buy the shares if the price of the stock falls to 110 francs per share. If and when the price dips to 110 francs, a market order is triggered and the broker buy the shares at the best available offers.
Example of a stop loss order: You buy 200 shares in a certain stock at 110 francs per share, and you want to protect yourself from heavy capital losses should the value of the stock fall. You place a stop loss order instructing your broker to sell your shares if their price falls to 108 francs per share. If and when the stock’s market price falls to 108 francs, a market order is triggered and the broker sells your stocks at the best available bids.
Stop orders are primarily used to prevent losses – either in the form of paying too much to buy or in the form of capital losses. This sets them apart from limit orders, which are used to maximize gains. In a limit order, orders will not be filled unless the broker can fill them at the limit threshold of better.
While limit orders give investors a great deal of control over orders, they are very rigid and can lead to losses. For example, if the price of a stock increases just slightly above the buy limit, the order will not be filled. If the price of an asset touches the sell limit but then falls slightly below it, the order will not be filled. Stop orders are more flexibile in that orders are filled as soon as the threshold is reached, regardless of whether the order can be filled at the threshold or better.
Stop orders can be combined with limit orders to form stop limit orders. These let you select both a stop threshold and a limit threshold. When you make a buy stop limit order, you select a stop entry threshold at which the purchase of assets is triggered and a buy limit so that the broker does not buy at a price higher than what you are willing to pay. When you make a sell stop limit order, you select a stop loss threshold at which the sale of assets is triggered, and a sell limit which prevents the broker from selling your assets for a price lower than what you are willing to sell them for.
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