STOP LOSS ORDER (also called a SELL STOP ORDER):
A Buy Stop order is entered at a stop price above the current market price. Investors generally use a buy stop order in an attempt to limit a loss or to protect a profit on a stock that they have sold short.
A Sell Stop or Stop Loss order is entered at a stop price below the current market price. Investors generally use a sell stop order in an attempt to limit a loss or to protect a profit on a stock that they own. The stop price is not the guaranteed execution price for a stop order.
A Stop Loss is an order placed with a broker to buy or sell once a stock reaches a certain price in order to limit a loss or to protect a profit on a stock that they own. For example, yesterday September 18, 2017, ARCM sold for $20 a stock. If you bought 100 shares of this stock today, it would cost you $2,000, you could put in a Stop Loss order for $17, that means if the stock drops below $17, your shares will be sold at the prevailing market price. Keep in mind that because a Stop Loss order becomes a sell at market order price, so if bad news comes out overnight and ARCM opens at $16, your sell may occur at the $16 open market price or even drop to $15, if the price is sliding fast. However, once your order is executed and say the stock continues to drop to $9, you may be happy that you got out of that stock and your loss was not greater.
And not to say this stock is going to drop tomorrow, it actually had a 0.05% gain yesterday. On a side note, you do want to pay attention to the volume of stock being sold every day, which for ARCM showed a volume of only 4,000 shares yesterday.
The Stop Loss order is in place if you do not want to watch the monitor the stock on a daily basis or know you will be out of town or unavailable to watch the stock and listen to the news on it. A disadvantage to a Stop Loss order is that could be activated by a short-term fluctuation in a stock’s price and could cause you to sell also costing you commissions. If the stock drops due to incorrect news that went out or some other reason, but is expected to go up immediately, then you are at a disadvantage because the Stop Loss order would cause you to sell.
The rule at when a Stop Loss order is placed vary from trader to trader, somebody who actively trades every day may use 10%, while a long-term investor may choose 15% or more. You need to keep in mind that once your stop price is reached, your stop order then becomes a market order and the price at which your stock is sold may be different from the stop price. Many new traders make the mistake of putting in a Stop Loss order and not understanding how volatile a certain stock can be and have a knee jerk reaction every time a stock starts to drop instead of waiting it out. Fear can make a person put in a stop loss order and sometimes you should just accept the risk of the trade. Sometimes it is better to have a mental stop loss than a physical stop loss order.
STOP LIMIT ORDERS
A Stop Limit order is similar to a Stop Loss order, however, the specified limit price is the only price that you will accept for the trade. As soon as the ask price hits your specified stop price, your trade becomes a sell at limit order. This does not guarantee that your order will be filled, you must ensure there is another party who will fill your order. This has happened to many stock traders including myself especially in a rapidly falling market.
For example, if tomorrow, ARCM opens because of bad news overnight at $10 a share, from a close of $20 today and you had a stop limit order instead of a stop loss order, your sell may never be executed and you will wish you had placed a stop loss order instead.
This is another reason why you should not have orders open when the market opens. Stop Loss orders are useful, but they do not eliminate all risk. You can either make sure that your stop order is filled (Stop Loss) or you can make sure that you can get the price you want (Stop Limit), but you cannot get both, it is one or the other.
Disclaimer: The information provided in this article is as a service to investors. It is neither a legal interpretation or a statement of policy. If you have questions concerning the meaning or application of a particular law or rule, please consult with an attorney who specializes in securities law. Stop Loss orders and Stop Limit orders may not be available through all brokerage firms. Investors should contact their broker to determine which orders are available for buying and selling stocks, and their broker’s specific policies regarding these types of orders.