A Stop Loss Order as Part of Your Investment Strategy

A stop loss order (or “stop market order”) is designed to limit an investor’s loss on a stock or other security position by instructing the broker to sell when it reaches a certain price.

In executing a the order, investors ensure they get out of a stock at a pre-defined loss before the stock price falls any further (set the stop loss order for 10% below the price and you limit your loss on that order to 10%).

Stop loss orders can function as insurance policies and can save stock investors from very big losses. Many financial advisors would tell you that, unless you plan to hold a stock for the long-term, you should consider using these order types to minimize your downside risk. In using a stop loss order, you take the emotion out of your sell decision by incorporating this automatic trigger.

It is also a good idea to consider using a stop loss if you plan to be away and unable to react to market changes for a period of time.

You execute a stop loss order at a specified price. If the price of the stock falls to that level, your order becomes a market order, requiring the broker to sell the stock immediately at the best market price available. It is recommended that investors exercise good judgment in setting the stop loss point. If the stock price is known to fluctuate within a certain range it may be advisable to set the price below the range of what may be a normal and temporary downswing for the stock.

The use of the stop loss order does have its critics. Fundamental investors, for example, argue that you may not want to sell a stock just because it has depreciated in value. These investors will tell you that the stock price will recover if the company has strong fundamentals (they might even see the lower price as a good opportunity to acquire more shares).

Critics will also tell you that in setting the stop point, you are guaranteeing a loss for yourself. Locking into that loss becomes a much worse proposition if the stock recovers and begins a dramatic march upward.

Still, stop losses are often seen as an important part of a trading strategy, enabling the investor to make the sell decision when they still have an objective opinion on the stock.

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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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