How Stop Orders Can Save You Time And Money
Stop orders are not complicated. When we use the word “stop,” we’re referring to stop orders. This is an order that directs your broker to sell a position you hold long if it drops to a specified price. If you’ve sold short, you can place a stop-loss buy-to-cover order to get out of the position if it rises to a specified price. Once the stop orders have been triggered, it’s immediately executed as a market order.
Here’s an example. Let’s say you buy a stock at $50 a share. You have reason to think it will rise, but you also realize it’s a risky trade. You know that if the stock drops below $48.50, it means there’s with the trade and you’ll want out. How can you be sure to get out if the stock drops below $48.50? You have to set your stop orders.
After buying the stock, you place your stop orders at $48.40. This tells the broker that any execution in the market for $48.40 or less is an automatic trigger to sell your shares immediately in the form of a market order — they’ll be sold at the current bid, whatever that is.
These stop orders will happen automatically, which means you won’t have to watch the stock closely. It also means you won’t be tempted to hold on longer, hoping that the stock will go back up.
In general, there are two types of stop orders: stop-toss and stop-limit. Stop-loss order are stop orders to sell a position if it drops to a specified price or to buy to cover a position you sold short if it rises to a specified price. Once the stop orders are triggered, the stop orders are executed immediately at the market price (it becomes a market order.)
A stop-limit order are stop orders to sell a position at a specific price and no lower than that price if it drops to that price, or to buy to cover a stock sold short at a specific price and no higher than that price if it rises to that price. Once the stop orders are triggered, the stop orders are executed only if it can be executed at the limit price or better (it becomes a limit order.)
Let’s say a stock does drop. It hits $48.40, and your stop orders are triggered. Your stop orders become a market order to sell. This means that it will execute immediately at the current bid price. The same principles apply to stops on short positions. If you sell a stock short at $13, expecting it to go down, you’ll place a stop buy-to-cover order at, say, $13.75. If it suddenly rises sharply, you’re protected - and you can always re-short the stock at a higher price when you believe it’s reached its peak.
