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A hard stop is an investment strategy that involves setting a price level that triggers the sale of security in the event that level is reached. Sometimes referred to as a good ‘til canceled approach, investors sometimes set this type of limit order in place as a means of making sure that the security is sold before the price can drop below what the investor has determined is an acceptable level. Depending on the nature of the security, the hard stop may be the basis for the issue of a stop-limit order that the broker can execute automatically, without the need to consult the investor in advance.
One of the benefits of establishing a hard stop is that it prevents the investor from losing money on an investment. For example, if a round lot of a given stock is purchased for $100 US dollars (USD) per share, then subsequently increases in value to $125 USD per share, the investor may choose to set a hard stop of $110 USD per share. Doing so helps to ensure that some sort of return is realized, even if the trend with the stock reverses at some point. This strategy means that at the time the limit order is executed, the investor not only recovers the original investment, but also earns a profit of $10 USD per share.
The type of order that can be created using this hard stop will vary somewhat. With some investments, brokers and dealers will not accept a stop-limit order, but will accept a limit order or a stop order. While all these orders are similar, there are slight differences. A limit order sets a price range that must be met before the investor will sell, while a stop order requires that the price be set at a specific amount. For example, a limit order would allow the broker to sell the shares once the price fell into the designated range, without waiting for the minimum acceptable price to be reached. With a stop order, the security would be sold only when the price reached the specific rate identified by the investor as the hard stop.
It is important to note that an order that includes a hard stop remains in effect until either it is executed or the investor chooses to cancel the order. If the value of a given security never falls to the level of the hard stop, then the order remains active, but is never actually placed by the broker holding the order. This approach makes it very easy for investors to set limits and devote attention to other projects, rather than having to monitor the movement of the security on an ongoing basis.
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