Stop Orders, Stop-Limit Orders and Trailing Stops — In Plain Words

What is a stop order?

The bulletin says a stop order, also referred to as a stop-loss order, is an order to buy or sell a stock once the price of the stock reaches a specified price, known as the stop price.

When the stop price is reached, a stop order becomes a market order.

In plain words: the stop price is a trigger. Nothing happens until the price reaches it. Once it is reached, the order turns into a market order.

Buy stop orders and sell stop orders

The bulletin describes the two directions this way:

• Buy stop order. A buy stop order is entered at a stop price above the current market price. The bulletin says investors generally use a buy stop order in an attempt to limit a loss or to protect a profit on a stock that they have sold short.
• Sell stop order. A sell stop order is entered at a stop price below the current market price. The bulletin says investors generally use a sell stop order in an attempt to limit a loss or to protect a profit on a stock that they own.

Those two sentences describe what the bulletin says investors generally do. They are not instructions on this page.

The central warning: the stop price is not a guarantee

The bulletin states this warning in bold. Here it is in the bulletin’s own words:

The bulletin explains why. The stop price is a trigger that causes the stop order to become a market order. The execution price an investor receives for this market order can deviate significantly from the stop price, due to the prices of available liquidity when the market order executes.

The bulletin also notes one way the two order types differ here. An investor can avoid the risk of a stop order executing at an unexpected price by placing a stop-limit order. A stop-limit order includes a limit price that requires the order to be executed at the limit price or better — but the limit price may prevent the order from being executed.

Two more cautions about stop orders

A short-lived price move can trigger the order. The bulletin says a stop order may be triggered by a short-term, intraday price move. That can result in an execution price for the stop order that is substantially worse than the stock’s closing price for the day. The bulletin tells investors to carefully consider the risk of such short-term price fluctuations in deciding whether to use a stop order and in selecting the stop price for an order.

Firms do not all use the same trigger standard. The bulletin says different brokerage firms have different standards for determining whether a stop price has been reached. Some brokerage firms use only last-sale prices to trigger a stop order, while others use quotation prices. The bulletin tells investors to check with their brokerage firms to determine which standard would be used for stop orders.

What is a stop-limit order?

The bulletin says a stop-limit order is an order to buy or sell a stock that combines the features of a stop order and a limit order.

Once the stop price is reached, a stop-limit order becomes a limit order that will be executed at a specified price (or better).

The bulletin states the benefit this way: “The benefit of a stop-limit order is that the investor can control the price at which the order can be executed.”

The bulletin also gives the limit on that control. As with all limit orders, a stop-limit order may not be executed if the stock’s price moves away from the specified limit price.

The bulletin’s stop-limit example

This is the worked example printed in the bulletin. The stop price and the limit price in it are the bulletin’s numbers, not numbers chosen on this page.

The bulletin gives stop-limit orders the same two cautions it gives stop orders. A stop-limit order may be triggered by a short-term, intraday price move. And different brokerage firms may have different standards for determining whether the stop price of a stop-limit order has been reached: some use only last-sale prices to trigger a stop-limit order, while others use quotation prices.

What is a trailing stop order?

The bulletin says a trailing stop order is a stop or stop limit order in which the stop price is not a specific price.

Instead, the stop price is either a defined percentage or dollar amount, above or below the current market price of the security. The bulletin calls this the “trailing stop price.”

As the price of the security moves in a favorable direction, the trailing stop price adjusts, or “trails,” the market price of the security by the specified amount.

However, if the security’s price moves in an unfavorable direction, the trailing stop price remains fixed. The order will be triggered if the security’s price reaches the trailing stop price.

The bulletin’s trailing stop example

This is the worked example printed in the bulletin. The stock in it is called “XYZ.” XYZ is the bulletin’s example name. It is not a real stock pick, and it is not a suggestion.

The bulletin gives trailing stop orders two cautions of their own. Investors should carefully select the trailing stop price they use for a trailing stop order, since short-term market fluctuations in a stock’s price can activate a trailing stop order. And, as with stop and stop-limit orders, different trading venues may have different standards for determining whether the stop price of a trailing stop order has been reached: some exchanges use only last-sale prices to trigger a trailing stop order, while other venues use quotation prices. The bulletin tells investors to check with their brokerage firms to determine which standard would be used for their trailing stop orders.

Not every firm offers all three order types

The bulletin opens with this note, printed here in its own words:

What FINRA says — kept separate

FINRA is a separate source from the SEC bulletin. FINRA’s words are in this section only, under FINRA’s name. They are not mixed in with the bulletin’s words above, and where FINRA’s wording differs from the bulletin’s, both wordings stand as written.

FINRA defines a stop order this way: it is an order to buy or sell a security once the price of the security reaches a specified price, known as the “stop price.” When this stop price is reached, FINRA says, the order automatically turns into a market order and is executed as soon as possible at the current market price.

FINRA describes the two directions this way:

• Sell stop order (FINRA). FINRA says this type of order can help limit your losses if a stock you own falls more than you’d like. When triggered, the order becomes a market order, with shares sold at the current market price.
• Buy stop order (FINRA). FINRA says that with a buy stop order, you set a target price, and a market order to buy shares is automatically placed when the stock price hits your threshold.
• Stop limit order (FINRA). FINRA says that if you don’t like the normal situation in which a stop order triggers a market order, you can instead place a stop-limit order, in which your stop order is designed to trigger the activation of a limit order.
• Trailing stop-loss order (FINRA). FINRA uses this name, “trailing stop-loss order,” where the bulletin says “trailing stop order.” FINRA says this type of order is similar to a regular stop order, only this type of order sets your stop price differently: in a trailing stop-loss order, you tell your brokerage firm that you want to sell if your stock declines a certain percentage or dollar amount from its market price at the moment.

One difference stands as written, unmerged: FINRA’s trailing stop-loss description is written as a sell order only. The bulletin’s trailing stop description is written for a stop or stop limit order, with a stop price above or below the current market price. This page does not combine those two descriptions into one.

FINRA also says investors use stop orders as a tool to manage market risk. FINRA says you can generally use sell-stop orders to limit a loss or protect a profit position in the event the stock’s price changes, and that if you have a short position, you can generally use stop-buy orders to limit losses in the event the stock’s price increases. FINRA also advises asking your brokerage firm what types of orders you can place and what they cost, and asking about your firm’s procedures for handling the execution of securities transactions and different order types, particularly during volatile market conditions, because not all orders are handled the same way.

One cross-reference

This page is the sequel to the companion page on the two basic order types, and it does not repeat that page: Limit Order vs Market Order — In Plain Words.

This page is general information only. It is not financial advice.

This page only explains what stop orders, stop-limit orders, and trailing stop orders are, in the SEC bulletin’s own framing, with FINRA’s separate wording kept in its own section. It decides nothing about any stock, company, or trade.