What Is a Stop Order?
When an investor instructs their broker (usually via a trading application on their phone or computer) to buy or sell a stock on their behalf, they do so with an order. There are three main types of orders—market, limit, and stop.
A stop order is unique in that it instructs a broker to buy or sell a stock immediately if it trades at (or past) a specified “stop price.” The stop price is not necessarily the price at which the order will execute, however—the stock reaching the specified stop price is simply what triggers the order to execute. Instead, stop orders execute at the current market price for the stock in question, which can be different from the stop price that triggered the order if the stock is experiencing a lot of volatility (e.g., during a selloff or a rally) and its price is fluctuating rapidly.
The way a stop order actually works is by turning into a market order once the specified stop price is reached. (A market order simply instructs a broker to buy or sell shares at the best price available as soon as possible). Think of a stop price like a trip wire—it triggers the purchase or sale of stock immediately, whether the price that triggered the order is still the current market price or not.
Stop Orders at a Glance
- What? Buy or sell shares of a stock
- When? Once stop price is reached or exceeded
- Price? Current market price
Why Do Investors Use Stop Orders?
To Lock in Gains
If an investor has purchased a stock, and that stock has since gone up in value by 35%, that investor may want to protect their gains should the stock experience a reversal. For this reason, they might place a stop order with a stop price 30% above their cost basis. This way, if news or events cause the stock to begin to fall significantly in price, their position will automatically be sold before it loses too much value. This way, their gains will be locked in—even if they aren’t actually watching the market.
To Prevent or Reduce Losses (Stop-Loss Order)
If an investor has just opened a long position in a stock, they might want to prevent or minimize losses on that position. Volatility is normal, so the investor might place a stop-loss order with a stop price 10% below their cost basis. This way, if the stock falls by more than 10%, their position will close automatically, limiting their potential losses should the stock continue on a downtrend. Stop-loss orders essentially allow investors to “panic sell” if a stock reaches or passes a specified price without watching the market.
To Purchase a Stock as It Breaks Out
Some investors buy and sell stocks based on momentum—in other words, they hop on trends of buying and selling as they occur and “ride the wave” briefly before exiting their positions and pocketing their gains.
This sort of momentum investor may have their eye on a particular stock that has been bouncing around between its support and resistance levels within an established channel for a while. This investor could place a stop buy order with a stop price slightly above the stock’s resistance level so that if the stock breaks out (moves above its resistance level), a long position is initiated automatically. In theory, this breakout should signal an uptrend that the investor can capitalize on for a while before selling the stock at a higher price and locking in their gains.
Do Stop Orders Expire?
Stock orders may or may not expire. Different brokerages offer different options when it comes to customizing stop orders. The two most common types of stop orders are day orders, which expire at the end of the current trading session, and good-till-canceled (GTC) orders, which don’t expire unless they are canceled manually by the investor. Some brokerages may allow investors to set up stop orders such that they expire after a custom amount of time if not yet executed.
Do All Stop Orders Execute?
Stop orders execute if two things are true: the stop price is reached or exceeded and there is enough liquidity in the stock in question for the trade to execute (this is usually not an issue on major stock exchanges).
What Other Order Types Are There?
Stop orders are only one of three main categories of orders an investor might use to buy or sell shares. The others—market and limit orders—function a little differently.
Market orders are the most simple and straightforward—they simply instruct a broker to buy or sell a particular stock at the best available price as soon as possible. Market orders are what stop orders turn into once the specified stop price is reached. They don’t guarantee any specific price, so they execute at the best market price available, which is usually close to the last price quoted for the stock on its exchange.
For stocks with low trading volume and wide bid-ask spreads, however, market orders can be risky, as market price can change more significantly between trades. For this reason, market orders are best suited for large, popular stocks that trade on major exchanges, with good liquidity and high trading volume.
Limit orders are very similar to market orders—they instruct a broker to buy or sell shares of a stock if and only if they reach a certain “limit price” specified by an investor. Unlike stop orders, however, limit orders do not turn into market orders once the specified limit price has been reached. Instead, they only execute at the limit price or better. There is no risk of a limit order executing at an unfavorable market price due to a sudden change in supply or demand. This feature is advantageous, but it can make the order slightly less likely to execute than a stop order at the same price.
Order Types at a Glance
Once limit price is reached
Once stop price is reached
Best available (market)
Limit price or better
Best available (market)
When specified by investor
When specified by investor