Stop-loss order

Definition:

An order to unwind a position when the price moves against you. This order is designed to limit losses or in some cases to lock in a certain level of profit. As soon as the price of the security hits the stop-loss price (or falls below), the order becomes a market order. If you were short the asset, the stop-loss would trigger a purchase. Stop-losses are often disabled for after hours trading because prices are often quite variable and you could be executed at an unfavorable price. Stop losses are also usually calculated off the bid price (which is a measure of what people are actually willing to pay if the security is sold). Again, one needs to be careful because if there is lack of liquidity, the bid-ask spread could be large and you could be stopped out at an unfavorable price. Finally, some traders have rolling or trailing stop loss. As the price moves up the stop-loss is moved higher (say 20% below the current price).

Investing Essentials


Copyright © 2011 Campbell R. Harvey, Professor of Finance, Fuqua School of Business at Duke University

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