Stop loss orders are most closely related to insurance, except a wide majority of so called investors don't even know they exist. Stop loss orders will not only allow you to trade away from your computer, but may also save your portfolio over the long haul.
If you have dipped into how market orders and limit orders work, than understanding stop orders will be an ease. And actually, even if this is the first time you have heard of such a thing, you still should not have too tough of a time figuring these guys out, they are really quite simple!
What They Do
Stop orders work like insurance so that in case something bad happens, you will be covered. In stock market terms, this means that if you hold 100 shares of Google at $500 a share and you don't want to lose more than 10% on your money, than a stop loss order will automatically sell your shares for you if Google falls below $450.
To explain this even more simply, think of automatic triggers. Like from movies for example, they always say never to "never press the red button". Why? You don't want to find out. Well someone presses it and something always blows up somewhere! In the case of the stock market, your red button is your safety button against your position. If you have $100,000 in a stock but don't want to lose more than $1,000, a stop order (your red button) will automatically sell your shares so you don't lose a penny over $1,000!
Types of Stop Orders
There are twp types of stop loss orders, stop market orders and stop limit orders
- Stop market orders will automatically sell the shares desired for you at the market once the order is activated. So, let's say you own 100 shares of XYZ and you place your stop market order at $9.80 for 100 shares. Well, if the stock EVER hits $9.80 a share at any time during the day, the order is "activated" and your position is liquidated (or sold) on the market! (You can read more on stock market orders here)
- Stop limit orders will automatically place a limit order whenever the trigger price is hit. So with our same 100 shares of XYZ stock, if we place a stop limit order at $9.80, whenever $9.80 is hit (if it ever hits), our limit order gets activated and becomes live. When placing a stop limit order, you need to also figure out what limit order you want. This is more 202 based, but nonetheless it is effective! (You can read more on stock limit orders here)
How to Place an Order
Stop orders are setup by you manually when you go to make a trade online.
Through your online stock broker you can make these types of trades, and depending on which broker you currently utilize, your fees will vary. MOST brokers charge the same fee to place a stop order as they do to place a regular market order. If you are trading with any of the big three brokers, this will be case!
To place a stop order of any kind, you simply log in to your account, and go to "trade stock" or "trade" and fill out the simple form for your order. Check the stop order box or chose it from the pull down menu to designate that type of order. Fill out the form, place the trade, and you are done!
One last note here about stop orders, you can typically set their expiration to whenever you'd like. You could make it so the order is only good for that day, that week, one month, one year, or forever. What this allows you to do is leave your computer and go on vacation or be out of the house and not worry about your portfolio falling substantially in value while you are out! Everything is automatic, which really makes for some great insurance.