If you own a stock and want to avoid a loss, you can enter a sell stop order to trigger if that stock reaches the predetermined price below its current value, limiting your losses.
Example of a Stop Market Order
Sally, the investor, owns shares of ABC Foods, currently priced at $100 per share. She purchased ABC Foods at $85 per share and has made a decent profit already. She believes the stock price has the potential to continue to rise even more, should the price reach $105, and she would like to take part in that momentum. So Sally enters a buy stop order to buy additional shares of ABC Foods at $105 per share. Sally already has made a decent profit because her original purchase price of ABC Foods was $85 per share. She wants to protect that profit should the stock price drop. To do so, she would need to sell her shares before the price breaks even at $85, preferably at a price where she still makes a profit. Sally also enters a sell stop order at $95 per share, in the event that ABC Foods drops in price. If ABC Foods drops to $95, her sell stop order will become a market order and sell her shares to lock in her profits. By entering a buy stop order of ABC Foods at $105 per share, Sally is preparing to take part in additional profits as the stock price rises. By entering a sell stop order at $95, Sally is protecting her profit if the stock price drops.
Types of Stop Market Orders
There are two kinds of stop orders: buy stop orders and sell stop orders. Both types of orders are scheduled orders that become a market order once the stock reaches the predetermined price.
Buy stop orders: These are orders entered at a price above the current market price. Buy stop orders can be used to partake in additional growth of a stock as it trends upward or to protect against loss should an investor own short positions of the underlying stock. Sell stop orders: These are orders entered at a price below the current market price. Sell stop orders can be used to protect one’s profits or limit losses in a stock they currently own.
Stop orders are also often referred to as “stop loss orders” because they frequently are used to limit the losses in current market positions.
