Stop Loss Order
A stop-loss order is an order placed with a broker to buy or sell once the stock reaches a certain price. It is designed to limit an investor's loss on a security position that makes an unfavorable move. Setting a stop-loss order for 10% below the price at which you bought the stock will limit your loss to 10%. One advantage of the stop-loss order is that it costs nothing to implement.
There is a tradeoff to using stop losses
- Sometimes they help - you lose less than you would have otherwise
- Sometimes you end up being stopped out near a bottom and miss a recovery rally
- Research from MIT processor Andrew Lo and PHD student Kathryn Kaminski shows mixed results
- For some strategies stop losses help, but for other strategies they hurt
Tips on How to Best Use Stop Losses
- put it far enough away from current prices to allow for the markets/stocks normal day-day volatility
- If the stop loss is too close, you might get stopped out too early/frequently