What is a stop market order?

A stop market order is a scheduled order to buy or sell a stock when the price of that stock reaches a predetermined price, known as the stop price. Stop market orders are commonly used by investors to limit their losses or protect their profits in case the market moves in the wrong direction.

How do stop market orders work?

Investors can place scheduled orders at predetermined price levels that activate automatically if the stock price reaches its specified value. If you believe that the stock might have upward momentum if it reaches a certain price, you can enter a stop buy order to buy at that specified price and participate in the upward trend of that stock.

If you own a stock and want to avoid losses, you can enter a stop sell order to activate if the stock reaches a price below its current value, thus limiting your losses.

Example of a stop market order

Sally, an investor, owns shares in ABC Foods, which currently trades at $100 per share. Sally bought ABC Foods shares for $85 per share and has already made a good profit. She believes that the stock price has the potential to rise further if it reaches $105, and she wants to participate in that momentum. Therefore, Sally enters a stop buy order to purchase additional shares of ABC Foods at $105 per share.

Sally has already made a good profit since her original purchase price for ABC Foods shares was $85 per share. She wants to protect that profit in case the stock price declines. To do this, she will need to sell her shares before the price drops to $85, preferably at a price that still allows her to profit. Sally also enters a stop sell order at $95 per share, in case the price of ABC Foods decreases. If the price of ABC Foods drops to $95, the stop sell order will become a market order and will sell her shares to secure her profits.

By entering a stop buy order for ABC Foods shares at $105 per share, Sally is preparing to participate in additional gains as the stock price rises. By entering a stop sell order at $95, Sally protects her profit if the stock price drops.

Note: Stop market orders may be executed at prices other than the predetermined price in a fast-moving market. Why? Because stop market orders simply activate the order to become a market order when the stop price is reached, which means they can be executed at any current market price after reaching the stop price.

Types of stop market orders

There are two types of stop orders: stop buy orders and stop sell orders. Both types of orders are scheduled orders that become market orders when the stock reaches the predetermined price.

Stop buy orders: These orders are placed at a price higher than the current market price. Stop buy orders can be used to participate in additional growth of a stock with its upward trend or to protect against loss if the investor has short positions in the underlying stock.

Stop sell orders: These orders are placed at a price lower than the current market price. Stop sell orders can be used to protect profits or limit losses in a stock that the investor currently owns.

Stop market orders are often referred to as “stop-loss” orders because they are frequently used to limit losses in current market positions.

Stop market orders vs. limit market orders

Stop market orders limit market orders

Becomes a buy/sell order for the stock executed at any market price after reaching the stop price. The buy/sell of the stock is executed at the market price after reaching the stop price.

Becomes

Buying/Selling the stock is executed at a specified price or better after reaching the stop price.

What does this mean for individual investors?

By using stop market orders, investors can gain an advantage by limiting their losses or participating in additional gains by placing limits on when their buy or sell orders are executed. Whether you are a day trader or a long-term investor, stop market orders help investors manage their portfolio risks to their advantage.

Frequently Asked Questions (FAQs)

What is a stop market sell order?

A stop market sell order, also known as a stop loss order, is an order to sell at a stop price lower than the current market price. Stop sell orders are used to protect profits or limit losses in long positions.

What is a stop-loss order in trading?

A stop-loss order is an order to buy or sell a stock at a predetermined price, known as the stop price. When the stop price is reached, the order becomes a market order.

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Sources:

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we verify facts and maintain the accuracy, reliability, and quality of our content.

Schwab Streets. “3 Types of Orders: Market, Limit, and Stop”.

U.S. Securities and Exchange Commission. “Investor Bulletin: Understanding Order Types”.

Source: https://www.thebalancemoney.com/stop-loss-orders-market-or-limit-1031053