Stop-Loss Orders: An Effective Investment Safety Net
A stop-loss order is an instruction to a broker to buy or sell when the stock reaches a predetermined price, and is designed to place a limit on an investor’s loss if that stock should lose ground. For example, if an investor sets a stop-loss order for 10 percent below the price at which he purchased the stock, any loss is likely to be limited to 10 percent, because at that point an order to sell will kick in automatically.
As with any aspect of investing, there are positives and negatives. One of the advantages of a stop-loss order is that investors don’t need to monitor how their stock is performing on a daily basis, which can be a real plus for investors who have commitments preventing them from checking their stock. One of the disadvantages, which has become more of an issue of late, is that the stop-loss order could be triggered by a short-term fluctuation in price, which may be rectified almost immediately – but by then the stock is sold and the execution of the order has resulted in a commission having to be paid. This can be overcome to an extent by picking a stop-loss percentage that allows for fluctuation, while limiting downside risk.
In a volatile market it is important to remember that when the stop-loss order is triggered it becomes a market order, and is likely to sell at a completely different price from the predetermined stop-loss price, which could go either way – for or against the investor. Nevertheless, all things considered, a stop-loss order has a number of advantages in addition to those mentioned above. It costs nothing to implement a stop-loss order with usual commissions becoming payable only if a sale occurs. Also, some investors become attached to their stocks, willing to give them another chance even when there is every indication that it would be a good time to sell, and stop-loss orders eliminate this emotional aspect of investing.