A stop order is an instruction to buy or sell a security once the price reaches a specified level, used to limit losses or lock in profits.
Understanding stop orders
When a security trades at or past the specified stop price, the stop order immediately converts into a standard market order. The broker then executes the trade at the next available market price. Elephants use this tool to manage risk automatically, removing the requirement to monitor global market feeds constantly.
Traders utilize two primary types of stop orders. A sell stop order is placed below the current market price by an investor holding a long position, designed to trigger a sale if the asset drops in value. A buy stop order is set above the current market price and is used by short sellers looking to close a position if the asset increases in price.
There are risks associated with execution. Because the stop order becomes a market order upon triggering, the final execution price may differ from the stop price. This difference is known as slippage. Slippage occurs during periods of high volatility or when a market gaps between trading sessions. Regulatory bodies and exchanges across different countries handle order queuing and execution differently during these market gaps.
Example
An Elephant investor holds 1,000 shares in an agricultural logistics company listed on the Tokyo Stock Exchange. The shares are currently trading at 1,200 yen each. The investor decides they want to limit their downside exposure if the market turns against their position.
The investor places a sell stop order with a stop price of 1,100 yen. A month later, poor earnings cause the share price to drop to 1,100 yen. The stop order triggers and converts into a market order. The broker sells the 1,000 shares at the next available price, which happens to be 1,095 yen. The investor exits the position and prevents further losses as the stock continues to fall.