One of the best things a trader or an investor can do is preserve capital. The easiest way to do so is through a stop order. A stop order, often referred to as a stop-loss order, is a type of order that gets you out of an investment or trade when the investment or trade hits a specified price, to essentially stop you from further losses.
Stop Orders
A stop order turns into a market order when the price level or percentage is breached, getting you out of a stock or ETF as soon as possible at the market price.
Example: You buy 10 shares of a stock at $10.00 and enter a stop order for 10 shares at $9.00 (or 10%, some brokers do not allow percentage.) The stock moves around before heading lower and breaching the stop set at $9.00. Your stop order now becomes a market order selling 10 shares at the market price.
Stop Limit Orders
A stop limit order is much like a stop order, expect when the stock breaches your stop price/percentage, it creates a limit order instead of a market order.
Example: You buy 10 share of a stock at $10 and enter a stop limit order to sell 10 shares when the price hits $9.00 and for the limit order, you enter $8.75. The price of the stock hits $9.00, which then creates a limit order to sell 10 shares at or above $8.75.
Note: With stop limit orders, if the stock gaps down overnight, you run the chance of not getting your order filled.
Trailing Stop Order
Trailing stop orders are for those who want to limit their losses and lock in profits without actively monitoring the stock market. A trailing stop order is a stop order that moves up with the price of the stock.
Example: You buy 10 shares of XYZ stock for $10.00 and enter a trailing stop order at $1.00 below the buy price. Your trailing stop order moves up with the price of the stock, never allowing your stop order to trail the price of the stock more than $1.00.
Trailing Stop Limit Order
A trailing stop limit order, like the trailing stop order, limits losses while locking in profits. A trailing stop limit order turns into a limit order upon breaching a specified price level.
Example: You buy 10 share of XYZ stock for $10.00 and enter a trailing stop limit order of $1.00 for the stop and $1.25 for the limit. If the stock never goes up and starts falling, you should get out at $8.75 or higher. As with the trailing stop order, a trailing stop limit follows the stock up never allowing your stop to lag the price of the stock more than stop limit, in this case $1.00. Now, say the stock moves up to $12.50, then turns around and starts dropping. The stock hits your trailing stop, which is now at $11.50. In theory, your limit order will get you out at $11.25 or higher.
NOTE: Like the stop limit order; if the stock gaps down, you take a chance of not getting your order filled, as the bid is lower than your limit.
Placing Your Order
Different brokers offer different types of stop orders and some broker have limitations on certain types of stops such as limiting trailing stop orders by only allowing you to place them if you have more than 100 shares. The stop order can be placed either on the bid, the ask, last price etc. Be sure to place the order according to your plan or research.
Shorting Stock and ETFs
Stop orders work with shorting stocks as well. Instead of the stop being below the price of the stock, it is above it. If you are shorting stocks, I highly recommend that you place some type of stop order.
Pay Attention To Volume
If the stock or ETF that you are trading or investing in has low volume, a stop order or trailing stop might get you out at a price way lower than expected. When trading lower volume stocks or ETFs, you should consider using stop limit and trailing stop limit orders.
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