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What is a Stop-Loss Order?

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  • Written By: C. Martin
  • Edited By: C. Wilborn
  • Last Modified Date: 08 November 2016
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In finance, a stop-loss order is an instruction with a stock broker to sell an investment in a share automatically if the share price falls to a set price. The main aim of a stop-loss order, or stop order as it is sometimes called, is usually to control investor loss and protect the investor from steep falls in share prices. An experienced investor may purchase shares with a goal of making a certain percentage profit, and may also have a limit to the loss that he or she is prepared to risk making on the trade. The stop-loss order allows the investor to control the amount of potential loss that he or she would make on the trade if the share price fell.

Some of the advantages that investors may gain from using stop-loss orders include the ability to control or minimize loss, a reduced need for the investor to manually monitor his investments, and the provision of a method of setting a sell price for a falling stock and sticking to it while reducing the emotional element of the sell decision. Typically, a brokerage order for a stop loss does not incur any additional charges above and beyond those that the investor normally pays for his or her stock market trades. Due to these advantages, stop-loss orders are often recommended to beginning investors as a very important tool to reduce potential losses.

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As well as limiting losses, a stop-loss order may be used to lock in profits. If an investor has bought a share at a particular price and the stock has then increased in value, he or she can set a stop-loss order at a point lower than the current market price but higher than the original price at which the investor bought the stock. When a stock price continues to rise and the investor moves his or her stop-loss order up along with the price, this is termed a trailing stop.

There are some restrictions and disadvantages that may be encountered when using stop-loss orders. It is important for the investor to have some knowledge of the short term fluctuations that the share is likely to experience, in order to allow for these while maintaining the investment for the longer term. For example, if a highly volatile share typically fluctuates by 5% on a daily basis then a stop-loss order to sell if the share falls by 4% may not be an advisable strategy.

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