A stop order is a type of order used to buy or sell securities when the market price reaches a specified value, known as the stop price. Stop orders are generally used to limit losses or to protect profits for a security that has been sold short.
Sounds complicated? Let’s use an example to make it easy to understand.
Example 1 (sell-stop) - Long positions Sounds complicated? If you own shares that are trading at $10, you can place a stop-sell order at $9/share. If the stock price drops to $9, the stop-sell order will trigger and execute as a market order at the selected stop price ($9).
Example 2 (buy-stop) - Short positions Suppose you short stock XYZ at $20 as you anticipate its price to decline in value in the near future. But to protect your trade, you placed a stop-buy order at $22. If the stock price rises to $22, the stop-buy order will trigger and execute as a market order at that selected stop price ($22).
To conclude, for long (buy) positions, you set your sell-stop order below the current market price to protect yourself from losses. For short positions, you set the buy-stop order price above the current market. In either case, when your stop order price is reached, your order is processed as a market order as long as the price is reached within the duration timeline you specified.
Important to know:
- Stop orders are not allowed on Canadian exchanges
- When placing a stop order, you’re required to specify your order duration
- Good till extended market (GTEM) cannot be used when using a stop order