What is a Stock Stop Loss Order?
A Stock Stop Loss Order tells a broker to buy or sell a stock once the price of the stock reaches a specified price, known as the stop price. Investors use these orders to limit losses on a stock when it goes down if the investor is long the stock, or when it goes up if the investor is short the stock.
The idea of controlling losses may seem sound. But if you have done your homework and purchased a good investment, why would you want to sell it if it becomes cheaper? A stock stop loss order may cause you to sell just before the stock rebounds. Studies have shown that selling stocks that are down does not boost portfolio returns.
Another pitfall of stock stop loss orders is that you may not get your stop loss trigger price. Once a stop loss order is triggered it becomes a stop market order and will be executed at the next available price. That market price could be much lower than your specified stop loss trigger price.
2010 Flash Crash
On May 6th, 2010 the stock market experienced a “flash crash” where the Dow Jones Industrial Average, already down over 300 points, fell an additional 600 points in 5 minutes for a near 1000 point loss. Twenty minutes later the market had regained most of the 600 point loss. Many financial “experts” recommend using stop loss orders as a strategy to stop or limit a loss, but volatility makes the stop loss order a poor risk management strategy.
Stop Loss Order Example
Proctor & Gamble (PG), known to be a very stable low volatility stock, fell hard on May 6th, 2010 as stock loss orders were triggered and became market orders. PG went from $60 to $40 and back to $60 in less than 30 minutes. If someone had placed a stop loss at $45, when the price of PG declined to $45, that order became a market order and stock was sold at the next price available; possibly lower than $45. Minutes later PG had rebounded to $60, leaving investors stunned and unable to buy the stock back without a large loss.
The flash crash demonstrated that stop loss orders are often harmful to investment portfolios. Many investors with executed stop loss orders were harmed financially that day. Costly mistakes such as the stop loss order can be avoided by following the best stock investing strategies.
Related Reading:
“Maintain a Stock Buy List of Companies to Invest In”
| AAAMP Blog by Ken Faulkenberry | |
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Ken Faulkenberry earned an MBA from the University of Southern California (USC) Marshall School of Business with an emphasis in investments. Ken has 25 years of investment experience and is dedicated to helping people with self-directed investment management through the Arbor Investment Planner. His asset allocation strategies have an outstanding performance record. |
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