What Is Stop-Loss Order?
A stop-loss order automatically sells a stock when it drops to a specified price, limiting your losses. Learn how stop-loss orders work and their limitations.
Definition
A stop-loss order is an automatic instruction to sell a stock when its price falls to a level you set in advance. If you buy a stock at $100 and set a stop-loss at $90, the stock will be automatically sold if it drops to $90, limiting your loss to roughly 10%. The goal is to take the emotion out of selling -- you decide your pain threshold before the pain actually happens.
When the stop price is triggered, the order becomes a market order and executes at the next available price. This means in a fast-moving sell-off, you might get filled at $89 or $88, not exactly $90. A stop-limit order addresses this by converting to a limit order instead, but it risks not filling at all if the price blows through your limit.
Trailing stop-loss orders are a popular variation: instead of a fixed price, the stop moves up with the stock price but never moves down. If you set a 10% trailing stop and the stock rises from $100 to $150, your stop adjusts from $90 to $135. You lock in gains while still protecting against reversals.
Real-World Example
You buy 200 shares of a tech stock at $75 and set a stop-loss at $67.50 (a 10% decline). The stock rises to $90 over the next month, and you raise your stop to $81 (10% below $90). One morning, the company reports bad earnings and the stock gaps down to $70. Your stop triggers at market open, and you sell at roughly $70 -- a $5 loss per share instead of the $20 loss you would have taken without the stop. Not perfect, but the damage is contained.
Why It Matters
Stop-loss orders enforce discipline. The biggest mistake individual investors make is holding losing positions far too long, hoping for a recovery that may never come. A stop-loss removes hope from the equation and replaces it with a plan. That said, stop-losses are not magic -- they can trigger during normal volatility, causing you to sell at the bottom of a temporary dip. Many long-term investors skip stop-losses entirely and rely on diversification instead. The right approach depends on your time horizon and risk tolerance.
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Frequently Asked Questions
What is a good stop-loss percentage?
There is no universal answer. Swing traders often use 5-10%. Long-term investors might use 15-25% or skip stop-losses entirely. The right percentage depends on the stock's volatility, your risk tolerance, and your investing style.
Can a stop-loss guarantee I won't lose more than my set amount?
No. In a gap down (the stock opens much lower than it closed), your stop triggers at the lower price. Stop-losses also do not work during market closures. They limit losses but do not guarantee a specific exit price.
What is the difference between a stop-loss and a stop-limit?
A stop-loss becomes a market order when triggered (guaranteed execution, uncertain price). A stop-limit becomes a limit order (guaranteed price, uncertain execution). If the stock is crashing, a stop-limit might not fill at all.
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