An order placed with a broker to sell a security when it reaches a certain price.
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Although most investors associate a stop-loss order only with a long position, it can also be used for a short position , in which case the security would be bought if it trades above a defined price. However, execution is not guaranteed, particularly in situations where trading in the stock is halted or gaps down or up in price.
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With a stop-loss order for a long position, a market order to sell is triggered when the stock trades below a certain price, and it will be sold at the next available price. This type of order works well if the stock or market is declining in an orderly manner, but not if the decline is disorderly or sharp.
For example, if you own shares of ABC Co. This type of stop-loss order is also called a sell-stop order.
How does a stop-loss order work, and what price is used to trigger the order?
This is a major drawback of stop-loss orders, and is a reason why experienced investors use stop-limit orders instead of stop-market orders. Stop-limit orders seek to sell the stock at a specified limit price — rather than the market price — once a specified price level is breached.
Although stop-limit orders will also not work if the stock is halted down or has a price gap, the risk of the long position being sold at a significantly lower price than the specified stop price is lower than with a stop-market order.
Note that these orders can also be used to protect unrealized gains , although in this case it would be more accurate to refer to them as stop orders rather than stop-loss orders.
Go deeper by reading our article on The Stop-Loss Order - Make Sure You Use It.
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