In this article, you will learn what is a stop-loss order. A stop-loss is an order placed on the terminal to buy or sell a stock after reaching a certain price level. A stop-loss is a great tool to protect ourselves from losses when we don't have the time and the ability to monitor multiple stocks at the same time, throughout the day.
What is a Stop-Loss Order?
A stop-loss order is a type of stock order that enables an investor to limit the potential loss on a stock position by setting a price limit that triggers the stock's trade and a stop-loss order is simply an order that enables us to close a position if the price reaches a certain level.
Investors primarily use stop-loss orders to limit their losses on stock positions and reduce their portfolio risks. While stop-loss orders can be useful, it's important to realize they don't always work as intended. stop-loss orders can also lock in avoidable losses, which is why The Motley Fool favors buying and holding quality stocks to build wealth over long periods of time.
What are the Advantages and Disadvantages of the Stop-Loss Order?
-Advantages of the stop-loss order
Investors use stop-loss orders as part of disciplined strategies to exit stock positions if they don't perform as expected. stop-loss orders enable investors to make predetermined decisions to sell, which helps them avoid letting their emotions influence their investment decisions
Brokers don't charge for setting up stop-loss orders (although some still charge commissions on the actual trades), making them essentially a no-cost insurance policy to limit losses on investments.
Routine use of stop-loss orders helps investors become more disciplined about selling losing stocks.
- Disadvantages of the stop-loss order
There are disadvantages to using stop-loss orders. First, establishing a stop-loss order doesn't limit an investor's loss to the difference between the purchase price and the predetermined sale price. If a company reports disappointing earnings after the market closes, for example, then its share price by the start of the next trading day could be well below an investor's stop-loss price.
Another potential pitfall of stop-loss orders is that they can trigger a stock sale even if the stock's price dips only slightly below the trigger price before quickly recovering. If a stock's price is volatile or another event occurs that causes a brief sell-off by other investors, that can trigger an investor's stop-loss order.
Finally, during sharp market declines, sophisticated investors like hedge fund operators sometimes try to take advantage of the existence of stop-loss orders. Known as "stop hunting," traders short stocks already in decline in order to push prices lower in an attempt to trigger a flood of stop-loss orders. These investors subsequently start buying those same stocks to profit from an expected rebound.
Bottom Line
Setting up of stop-losses is very under-rated, the profitability of our portfolio and the effectiveness of our strategy largely depends on stop-losses. Stop-loss should rampantly be used to avoid increased losses. This article is about what is a stop -loss order.
