The Sell Stop Order and Some of Its Uses

A Sell Stop Order is typically mentioned as a method to close an open Long Position in the case of a decline in share price, helping to minimize losses.

First, let's review what a Stop Order in general is: "An Order to Buy or Sell a Security once a specific price is reached."

Once the specified price is reached, you're order becomes a Market Order to be executed at the next available price.

As I mentioned above, typically you will read that a Sell Stop Order is used as a method to help minimize losses on a Long Position but let's look a little further at its various uses:

  • To help minimize losses on an open Long Position.
  • To Protect profits on an open Long Position.
  • To initiate a new Short Position.

You can see that I highlighted the third use above because you will rarely hear about this one for some reason. Let's take a look at each one in more detail: (Also read about using a Buy Stop Order here)

To Help Minimize Losses on an Open Long Position

Sell Stop Order- Minimize Losses

Once a Long Position is opened, a Sell Stop Order can be placed below your entry price to help minimize any losses you may have.

This is the most common use and you will often see it referred to as a "Stop Loss Order" or "Sell Stop Order". Sometimes you will see just "Stop" and have to make sure it is linked to the specific position you are trying to protect.

Once your specified price is reached, your order becomes a Market Order to be filled at the next available price.

To Protect Profits on an Open Long Position

Sell Stop Order- Protect Profits

Another use where the order placed can be used to help protect unrealized profits, just in case the share price begins to move against your position.

If you had an initial Sell Stop Order to help minimize losses as above and you begin to have unrealized profits, you could adjust the specified order price in your favor to help protect these profits.

Now, if the share price begins to move against your position and reaches the price you specified, your order becomes a Market Order, to be filled at the next available price.

To Initiate a New Short Position

This is the most often overlooked use. To understand how this can be used to initiate a new Short position, take a look at the following example:

Sell Stop Order- Short Position

So, an advantage of using a Sell Stop Order to initiate a new Short Position is that you don't have to monitor the security to determine if it will indeed move lower. This is a great way to try and catch a move based on an expected move after doing research over the weekend or in the evening.

For example: say you recognize a particular pattern forming and expect a breakout of the pattern soon. You can place the Sell Stop Order ahead of time to try and catch the move if it evolves.

As with everything in life, there are disadvantages as well. Your order can be triggered by a short term fluctuation in the price of the security, only to reverse shortly afterwards. Also, since your order will become a Market Order, increased volatility on a breakout can mean having an unexpected fill price due to a large number of other orders being filled near the same time as yours. This can happen with any Market Order.

Things To Consider

  • Make sure the security has enough average daily volume so that wide price swings due to lack of buyers and sellers don't cause unexpected outcomes.
  • Learn about using Stop Limit Orders as well to determine which is better for your situation.
  • Learn about using other types of Conditional Orders such as "One Triggers the Other" (at some brokers) which in this case can automatically enter a Stop Loss if your Sell Stop Order is filled to initiate a Short position.
  • Your Broker may not accept Stop Orders for certain securities so be sure to check first. Not all securities are eligible for Stop Orders and different Brokers may have different guidelines.

Related "Contingent Order" Pages on This Site:

Return From "Sell Stop Order" To "Stock Trading Risk Management"

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