Stop Order

1. Definition

A Stop Order is an order to buy or sell a security once the price of the security reaches a specified price, known as the Stop Price. When the stop price is reached, the stop order immediately becomes a Market Order. * It acts as a trigger: "If the price hits X, execute the trade immediately at the best available current price."

2. Types

2.1. Sell Stop (Stop-Loss)

Placed below the current market price. * Purpose: To limit a loss on a long position or to protect a profit on an existing stock. * Example: You own a stock at $100. You place a Sell Stop at $90. If the price falls to $90, the order turns into a market sell order to get you out of the position.

2.2. Buy Stop

Placed above the current market price. * Purpose: To catch an upward trend (breakout strategy). Investors use this to buy a stock only if it breaks through a resistance level. * Example: Stock is at $100. You place a Buy Stop at $105. You only want to buy if the momentum pushes the price past $105.

3. vs. Limit Order

• Limit Order: Guarantees the Price (or better), but does NOT guarantee execution.
• Stop Order: Guarantees Execution (once triggered), but does NOT guarantee the price.

4. Risk: Slippage

The main risk of a stop order is Slippage. Since it becomes a market order, the actual execution price can be different from the stop price, especially in volatile markets. * Scenario: You set a Sell Stop at $50. The stock closes at $51 and reopens the next day at $40 due to bad news (Gap Down). * Result: Your stop is triggered because the price is below $50, but your shares are sold at $40, significantly lower than your intended exit point.