What is a stop order?
A stop order is an instruction that you give to your broker to buy or sell a security when it reaches a certain price. It's a way of limiting the potential losses or protecting the potential gains of a trade, especially if you're not going to be able to monitor your portfolio closely.
Where have you heard about stop orders?
You may have placed a stop order with your broker when going on holiday, knowing that you wouldn't be able to keep a close eye on your portfolio while you were away. If you're an individual investor, you can also place stop order instructions on a trade you're conducting through an online platform.
What you need to know about stop orders...
Once the price of the security has passed the agreed price, known as the stop price, the stop order immediately becomes a market order and the broker will buy or sell the security at its current market value.
There are buy stop orders and sell stop orders. In a buy stop order the stop price is normally higher than the current market price. Investors use them to buy securities when the price reaches above this certain level. In a sell stop order the stop price is lower than the current market price. Investors use them to sell a security when it drops to a certain level.
Stop orders are also known as stop-loss orders and they can be a useful tool in cutting losses as well as protecting profits, especially with high risk trades. On the other hand they're not a guarantee. The trade will not necessarily go ahead at the exact stop price due to price slippage. Also, a stop order could be activated by a short term fluctuation in the market price of the security that is not representative of a wider trend.