A sell stop order is an order placed with your broker to sell a specified security once it has reached a predetermined price level, referred to as a stop price. By using a sell stop order, you are attempting to limit your risk from sudden market moves against your position and lock in unrealized profits.
Also referred to as a stop-loss order, when the price of a security falls to or below a preset price, it triggers a market order to sell the specified security. Your security will then be sold at the best prevailing price, although with market orders you can not be guaranteed the price that you will receive.
There are risks involved in using sell stop orders, and it is crucial to familiarize yourself with a sell stop order example to protect your self from unnecessary losses in your portfolio. Some brokers may not allow sell stop orders on certain types of securities, so it is also important to review your brokerage’s policies concerning stop orders.
A Sell Stop Order Example: Protecting From Loss And Realizing Profits
In this sell stop order example, you can protect your positions from market downturns as well as guard any unrealized gains you may have. It is crucial that you are familiar with your security’s typical inter-day trading range in order to properly set your sell stop order price.
If you own shares of a security that is currently trading at $50 per-share, and you place a sell stop order for $45 per-share, then if the price of the security falls to $45 or less, your sell stop order would then become a market order, allowing you to limit your losses.
You can also use a sell stop order to lock in unrealized profits on your investments. If you entered in to long position in a security for $50 per-share and the price has risen to $60 per-share, you can set your stop price for $55, guaranteeing a per-share profit of $5 should the market turn against your position.
Disadvantages To Using A Sell Stop Order
When considering a sell stop order example, it is important to keep in mind that there are some distinct disadvantages to using these types of orders. As a sell stop order automatically converts to a market order once the security has met your preset requirements, you can not be guaranteed that the price you wish to sell your security for will be the price you receive.
Therefore, you could stand to lose considerably more than anticipated, which can be potentially disastrous to your trading strategy. You may want to consider placing a limit order, which can help guarantee a sale price, but these types of orders come with their own set of risks.
It is also important to research a security’s typical volatility, in order to accurately set your stop price. If a security typically fluctuates by 15% over the course of a week, then a sell stop order set at 10% lower than the current price could be inadvertently triggered by a stock’s usual volatility.