Stop Orders and Stop Limit Orders
In common parlance, stop and stop limit orders are known as “stop loss” orders because speculators use them to lock in profits from profitable trades.
A stop order automatically converts to a market order when a predetermined price is reached (this is called a “stop price”). At that point, ordinary market order rules apply; the order is guaranteed to be executed, you just don’t know the price; it may be higher or lower than the current price reported in the stock symbol.
Trailing Stop Orders
One way to protect profits and limit losses automatically is to place a trailing stop order. With a trailing stop order, you set a stop price as a spread in points or as a percentage of the current market value.
Imagine that you bought 500 shares of Hershey Chocolate at $50 per share; the current price is $57. You want to lock in at least $5 of the earnings per share you’ve earned, but you want to continue to hold the stock, hoping to benefit from any further increases. To meet your goal, you can place a trailing stop order with a stop value of $2 per share.
In practical terms, here’s what happens: Your order will be placed on your broker’s books and automatically adjusted upwards as the price of Hershey’s common stock rises. At the time your trailing stop order was placed, your broker knows to sell HSY if the price falls below $55 ($57 current market price – $2 trailing stop loss = $55 sell price). Imagine that Hershey steadily rises to $62 a share; Now, your trailing stop order has automatically caught up and will guarantee at least a $60 selling price ($62 current share price – $2 trailing stop value = $60 per share selling price). In other words, the trailing stop order will increase in his favor and lock in any profit he has made in the meantime. If Hershey fell to $60, his trailing stop order would become a market order for his execution, his stock would be sold and should generate a capital gain of $10 per share.
Trailing stops, a form of stop loss orders, can also protect a profit and, if you’re smart, follow a stock’s price higher. Let me explain.
First, a quick review. A stop order placed with your broker is a way to protect yourself from a loss, should the stock drop. The stop loss order tells your broker to sell the stock when and if the stock falls to a certain price.
When the stock reaches this price, the stop loss order becomes a market order. A market order tells your broker to sell immediately at the best possible price. In a volatile market, you may not get the price you wanted, but it should be close.
Protect your earnings
This is how you protect yourself from a bad loss. Now, this is how you use the stop loss order to protect your profit on a stock that is going up.
There are two ways to enter a stop order. You can enter a dollar amount, for example, if your shares are selling for $40 per share, you can enter a stop order for $37.50 per share. When the stock price drops to $37.50, you trigger the stop order and the broker sells it.
However, what if you were lucky enough to (through careful research) have a growth stock that increased fairly steadily? Let me set a stage.
He bought the shares two years ago at $25 per share and it has grown 23% each year and is now at $38 per share. When you can stop patting yourself on the back, you start to get a little nervous that this growth spurt might be coming to an end.
end stop
Using our example, the trailing stop would come in at $34.20 per share ($38 x 10% = $3.80; $38 – $3.80 = $34.20).
If the stock continues to rise, so will the trailing stop. For example:
At $39 per share, the trailing stop is $35.51
At $40 per share, the trailing stop is $36.00
At $41 per share, the trailing stop is $36.90
At $42 per share, the trailing stop is $37.80
As long as stocks continue to rise or remain relatively flat, nothing happens. However, if it turns south and hits your trailing stop, your broker sells and you keep your profit. It is important to note that the trailing stop only goes up, never goes down with a market price.
The trick is to set the percentage at a level that picks up a true price drop rather than the normal daily price fluctuations.
conclusion
Several trading techniques use trailing stops. This example is a simple strategy to protect your profits. More advanced traders use it in combination with other maneuvers to extend their advantage. However, this strategy works well for beginner and intermediate investors who want to protect a profit, but let a winner run as long as possible.
Understanding stop loss orders
How Stop Loss Orders Can Protect You
When the price of your favorite stock plummets, a stop order filed with your broker can help ease the pain.
A stop loss order tells your broker to sell when the price reaches a certain point. The purpose of the stop is obvious: you want to get out of the action before it falls further.
A stop loss order works like this: You tell your broker that you want a stop loss order at a certain price on the stock. When and if the stock reaches that price, your stop order becomes a market order, meaning your broker sells the stock at the best available market price immediately.
set a stop
If the stock is trading at $30 per share and normally does not fluctuate more than $1-$2, then a stop loss order at $26.50 might be reasonable.
A good example of how investors could use the stop order was when Merck, the pharmaceutical giant, withdrew its successful arthritis drug Vioxx from the market. Studies have linked use of the popular drug with a higher chance of heart attacks and strokes.
As soon as Merck made the announcement, its shares began to drop like a rock because investors knew how much the company was banking on profits from the drug.
annihilated
By the end of the day, shares were down almost 27% or more from $11, wiping billions in value from the company.
The stock opened around $45 on the day of the announcement. If I had a stop loss order for $40, it would have been triggered very shortly after the announcement.
When the market reached your price of $40, your stop-loss order became a market order, meaning your broker sold the stock at the current best price. That may not have been $40.
A fast-moving market may overshoot your target before your broker can fill your order. The good news is that you probably want to get out of a plummeting stock at the best price you can get, and you’ll take what you can get.
You can also use stop loss orders to lock in profits by keeping the following in mind:
Be careful where you set your breakpoints. If a stock normally fluctuates between 3 and 5 points, you don’t want to set your stop too close to that range or you will sell the stock on a normal low.
Stop loss orders take the emotion out of a sell decision by setting a floor to the downside.
If you plan to be out of touch with the market, for example on vacation, place stop-loss orders to give yourself some protection against an unexpected disaster.
Stop orders do not guarantee losses. When a disaster hits a stock, it can drop so fast that the best you can hope for is to get closer to its price.
conclusion
Stop loss orders are great insurance policies that cost you nothing and can save you a fortune. Unless you plan to keep a stock forever, you should consider using them to protect yourself.
