The Secret to Using Stop Orders to Take Profits
This week we talked about different order types and how traders can use them to maintain a level of control over their trades even when they can’t watch the markets. They can assess their downside risk tolerance ahead of time and set their stops orders accordingly. But we didn’t really cover one of the most important – and perhaps most frequently issued – types of orders.
A stop order is an order to sell a security at a given price. Some traders use dollar-based stops, others use percentage-based stops (not to mention the all-important trailing stop, which adjusts to lock in profits as your trade moves up or down).
But here’s the secret not a lot of traders know…
When your stop price is reached, your stop orders become market orders. That means they are subject to the whims of the market, just like every other market order. If markets head lower and your stops are triggered, they may not be executed at your desired price.
For example, let’s say you bought a stock at $50 and set a $45 stop. The stock reports terrible earnings, sending the price plummeting. Your stop order is triggered at $45, but the stock price keeps falling, all the way down to $38. That’s where your stop order (now a market order) will be executed.
This is especially true for options, which can move quickly in both directions. So if you use stop orders to protect your profits, consider using stop-limit orders instead, which combine the advantages of stop orders and limit orders, allowing you to close your trade a specific price or better after you hit your stop price.