What is a Stop-Loss Order?
A stop-loss order automatically triggers a sale when a security's price falls to a predetermined level. For example, if you buy a stock at $100 and set a stop-loss at $90, the position will be sold if the price drops to $90, capping your loss at roughly 10%. Once triggered, the stop-loss converts into a market order and executes at the next available price.
Setting Effective Stop Levels
A common approach is to place stop-loss orders based on technical support levels or a fixed percentage below the purchase price. Many professional traders use a 7-8% stop-loss rule for individual stocks. For a $50 stock, that means setting the stop at $46-$46.50. Placing stops too tight, such as 2-3%, often results in being stopped out by normal daily volatility before the stock resumes its upward trend.
Key Considerations
Stop-loss orders do not guarantee execution at the stop price. In a gap-down scenario, where a stock opens significantly lower than the previous close due to overnight news, the order may execute well below the stop level. Stop-limit orders address this by adding a price floor, but they carry the risk of not executing at all if the price falls through the limit.