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Glossary
Stop Trading
Definition
In the financial world, a “stop” refers to a type of order that is executed once a certain price has been reached. A stop order is a request to buy or sell a financial instrument at a specific price (the stop price). Using a stop order allows you to have more control over your market orders.
What are stop-entry and stop-loss orders?
You can place a stop order to either open or close a position at a certain price. In other words, stops are applicable to both buy and sell orders.
Stop-entry order = an order used to open a position once the price hits a certain level
Stop-loss order = an order used to close a position once the price hits a certain level
As an example, you could set a stop-entry order if you want to buy shares in Tesla. Let’s say you set the stop price at $110. The price at the time of opening the order was $111. However, within a few hours of opening the order, the price of Tesla shares falls to $110. Your order is then filled (i.e., you buy shares) because the stop price has been reached.
Stops can also apply to sell orders. In this scenario, you’d set a stop-loss. Let’s say you already own shares in Tesla. You bought them at $100 and set a stop loss of $98. This means you want to sell the shares and exit your position if the price of Tesla shares falls to $98.
Stop orders allow you to have a certain degree of control over your trading activity because you’re defining the prices you want for buying or selling.
Stop orders vs market orders and limit orders
Market order = you want an order filled immediately at the next available price. This order favours the speed of execution. However, the price you pay might differ from the one quoted when you placed the order if the market is volatile. This is because you’re asking to take the next available price, regardless of movement.
Limit order = you specify a price, and the order doesn’t get filled until the asset can be bought at the limit price or lower (or sold at the limit price or higher). This order favours control over the price you pay. However, because you’ve set a limit, the order will only be completed once the limit is reached. Therefore, it might take a lot of time for the order to be filled. Alternatively, the order might not be filled at all (if the limit isn’t reached). This type of order is best if you want to enter/exit a position at a certain price.
Stop order = You want an order triggered at a specified price. A stop order can be a market order or a limit order. Once the stop price has been reached, the order is executed according to its type (see below for the three types of stop orders).
Types of stop orders
Here are three types of stop orders you can use:
Stop market = when the trigger price is reached, an order is placed to buy/sell the asset at the next available market price (the market value). Like a market order, this method can help fill the request quickly. However, the order might be filled at a different price than expected because there isn’t a limit—you’re simply taking the next available price.
Stop limit = when the trigger price is reached, an order is placed to buy or sell (depending on which you selected) the asset at the limit price or better. This order gives you more control over the price you buy/sell at because the order is only filled if the limit is reached (or if the price moves in your favor: above the limit for sell or below the limit for buy). However, the potential danger here is that the order won’t be filled quickly or at all if the limit isn’t reached.
Trailing stop = when the trigger price is reached, an order is placed to buy/sell the asset at a price based on a variable level. This means the order isn’t executed at the market price or a fixed limit. Instead, the execution price will move in line with market fluctuations. You can set a trailing stop as a cash amount or a percentage away from the current market rate.
For example, if you have a long position, you can set a trailing stop below the current market price to help lock in a profit. Let’s say you opened a position at $50 with a trailing stop of $5. This means you’d exit the position when the stock drops $5 below the current market value. So, at $50, the exit price would be $45. The asset’s price increases to $60, which means the trailing stop rises. Now the exit price is $55 because that’s $5 below the market price.
What does a stop mean for traders and their portfolios?
Understanding stop orders is important for traders who want to take advantage of potentially profitable price fluctuations without having to constantly monitor the markets. Because you can set stop orders via trading platforms, you don’t have to watch price movements all day to find what you think is a profitable position.
The best way to use a stop is to go through the following steps:
1. Find an instrument you want to trade.
2. Check the current price.
3. Carry out various forms of analysis to determine the status of the market (e.g., is the instrument bullish or bearish and, moreover, is it undervalued or overvalued?).
4. Make a judgement based on your analysis as to which direction the price may move. (Will it continue its current trajectory or is a reversal likely?)
5. Based on the information you’ve gathered and your own assessments, determine a price you think gives you scope to make a profit.
6. Choose the type of stop order you want to set. Do you want to execute the order quickly? If so, a stop market order might be best. Do you want to execute at a specific price? If so, a stop limit order might be best. Do you want a variable limit that can help lock in a profit, even if it takes more time to execute the order? If so, a trailing stop might be best.
One type of stop isn’t necessarily better than another. It all depends on your preferences, what you’re trading, and the markets.