Updated on September 20th, 2019
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Stop Market Orders give your broker instructions on how to buy or sell a security, like a stock, after a specific price is met. With a Stop Market Order, you set a stop price and how many shares of the stock you wish to trade.
Depending on which online broker you are using, Stop Market Orders have many different names. To simplify things, we will divide Stop Market Orders into two commonly known orders: Stop Loss Orders & Buy Stop Orders. Let’s dive into Stop Loss Orders first.
Stop Loss Orders are primarily used to stop losses or to protect profits on stocks you already own without constantly checking your portfolio to do so. This is because a Stop Loss Order can be used to tell your broker to sell a stock when it reaches your stop price. Once this stop price is reached, your Stop Loss Order turns into a Market Order that sells the stock at the best available market price.
In order to make this work, you would select the “sell” option, choose a Stop Loss Order type, and set a stop price below the current stock price. This tells your broker to immediately sell you shares when the stock price has dropped below your comfort level.
For instance, if you own stock in Jake’s Tacos, and news leaks that some of their meat is causing customers to get sick, the value of your shares could drop immediately. Having a stop loss order in place can limit your losses or allow you to trade your stock for cash before a large amount of your profit disappears.
Buy Stop Orders work the same way, but instead are used to buy stocks. Commonly you will even notice that after selecting “Buy” on your trading app, Stop Loss is one of your options for order type. This is nothing more than a Buy Stop Order. Investors primarily use Buy Stop Orders to buy stocks that are building upward momentum, with an intuition that this a sign the stock price will continue to rise. This is why you would set the stop price above the current stock price instead of below it. The stop price you set is the price you are willing to “STOP” sitting on the sidelines and buy the stock.
Using our previous example, if Jake’s Tacos convinces customers that they have put standards in place to ensure this never happens again, investors might return to buying the stock. This buying could cause Jake’s Tacos stock to rise with strong upward momentum. Having a Buy Stop Order in place could allow you to catch the rise in stock price before it reaches its peak.
Stop Market Orders can be used as a great tool for buying and selling stocks without being glued to your app, but it is often overlooked that they execute as market orders once the stop price has been reached. This means that these orders have a great chance of being executed at a different price than the stop price, especially when stock prices are moving fast. This is because with a market order, your broker is focused on trading your shares immediately with the prices currently available in the market. For this reason, we recommend using Stop Mark Orders wisely by setting your stop price with this in mind!