The Scoop on Stop-Loss Orders

September 30, 2009
Michael Sheehan

Stop-loss orders can help your stock portfolio from sliding back to the lows of last March, preventing you from taking losses and locking in profits.

Are you worried that the stock market has topped out and is overdue for a fall? A good way to prevent your stock portfolio from sliding back to the lows of last March is the stop-loss order. A stop-loss order tells your broker to sell a stock when it reaches a pre-determined price. As its name implies, a stop-loss order is designed to prevent you from taking a loss on your stocks, but it’s also useful for locking in profits.

Here’s an example: Your stock in ABC Company hit a low of $60 a share several months ago. Now, it’s up to $90 and you don’t want to take the risk that it might take another big fall in the near future. So you give your broker a stop-loss order to sell the stock if it goes down to $85, preserving a $25 per share recovery. Another benefit -- you get to relax because you no longer have to track your stock’s price every day. If the stock continues to go up, you can use what’s known as a trailing stop-loss order, which pegs the sell price at a set percentage below the stock’s current price level.

There are some downsides. Stop-loss orders don’t work well with volatile stocks — sharp rises and dips in price may just end up losing you money in commission fees. It’s also important to realize that once the target price is reached, the stop-loss sell order become a market order; if a stock is in free-fall, your selling price may be much lower than the your stop-loss price target.