What is a stop order?
A stop order is a trading instruction from a trader to a broker to buy or sell an asset once it hits a specific price. After hitting a particular price, then the stop order becomes a market order that proceeds to execution at the most reasonable price. It may be beneficial to a trader since it avoids losses.
Advantages of a stop order
The order gets filled at the stock’s ongoing market price in a normal situation with a market order. However, in a stop order, the order waits until it hits a stop price. When we say stop price, we mean the trader’s desired price. So, after hitting the stop price, the order proceeds to execution.
Traders use this strategy when they do not have the luxury of too much time to keep an eye on their assets, especially for the volatile ones that can have massive price fluctuations, even just for a short period. For example, traders leaving for travel or vacation cannot pay full-time attention to their portfolios. So, they use stop orders to avoid any losses while away from the trading world.
These orders are very typical not just in stocks but also in foreign exchange markets. The swift changes that happen in a short period can make a trader take home massive gains. Aside from avoiding losses, stop orders can also give the possibility of securing profits on price changes.
Disadvantages of stop orders
As we have said, a market or limit stop order automatically executes after hitting the stop price. It is a fact that this is one of the stop order’s advantages since it avoids losses. It turns out that it is also one of its weaknesses. How? This very fact also tends to eliminate higher gains when there is an unexpected and massive price fluctuation.
For example, a trader’s order suddenly executed because there was a market flash. The price declined so fast but suddenly recovered. This trade could have given the trader good returns. However, the stop order executed the order after hitting the stop price and is irreversible.
Different types of stop orders
When we say stop order, we refer to not only one order but different types of orders. Let us define most of the common ones.
Buy stop order and sell stop order
Traders place buy stop orders with a stop price more than the current market price. On the other hand, its opposite is the sell stop orders since traders place them at a stop price lower than the market’s current price.
Stop market order and stop-limit orders.
Stop market orders are stop orders that became market orders after hitting the spot price. We also have stop-limit orders with essentially two more subtypes: buy stop limit orders and sell stop limit orders. Traders place a buy stop limit order higher than the market price, while sell stop orders are the opposite since traders place them lower than the market price.
There is also a term in trading called stop-loss orders. It is both linked with stop orders and limit orders.