Stop, Stop-Limit, and Trailing Stops: Complete Trading Guide

Educational beginner intermediate risk-management technical-analysis trading

What Is a Stop Order (Stop-Loss)?

A stop order—often called a stop-loss order when used for risk management—is an instruction to buy or sell a stock once it reaches a specific trigger price. When the trigger price is reached, the stop order converts into a market order, executing immediately at the best available price.

Consider this mechanism: An investor who purchased XYZ Corp at $50 might place a stop-loss order at $45. If XYZ declines to $45, the order activates and sells the shares at the prevailing market price.

Stop Orders for Entry

Stop orders aren't limited to exits. A buy-stop order can initiate a position when a stock moves above a certain level. This approach is often used when waiting for price confirmation before entering positions.

For instance, if DEF Corp trades at $30, just below a resistance level at $32, a buy-stop order might be placed at $32.10. When the stock reaches this price, the order executes automatically.

What Is a Stop-Limit Order?

A stop-limit order combines features of stop orders and limit orders. Instead of becoming a market order when triggered, it becomes a limit order. This requires specifying two prices: the stop price (the trigger) and the limit price (the maximum or minimum acceptable price for execution).

This order type essentially states: "When the stock reaches my stop price, execute a trade, but only within my specified price range."

Setting the Spread

The difference between stop price and limit price affects execution probability. A narrow spread increases the risk of non-execution, while a wide spread reduces the benefits of using a limit order. Common spreads observed in liquid stocks range from $0.25 to $1.00, with wider spreads for volatile or thinly traded securities.

Market observations show that during normal conditions, stop-limit orders with reasonable spreads function effectively. During periods of high volatility or gap movements, execution becomes less certain.

What Is a Trailing Stop Order?

A trailing stop order adjusts automatically as a stock price moves favorably, maintaining a specified distance from the market price. For long positions, the stop price rises with the stock price but remains fixed when the stock declines. This creates dynamic protection that adapts to price movements.

Trailing stops can be set as either a dollar amount or a percentage below the market price. As the stock rises, the stop price follows. When the stock falls, the stop price remains at its highest achieved level.

Percentage vs. Dollar Amount

The choice between percentage and dollar-amount trailing stops depends on the stock's characteristics:

• Percentage trailing stops scale automatically with the stock price. A 10% trail on a $20 stock ($2) is proportionally equivalent to a 10% trail on a $200 stock ($20).
• Dollar-amount trailing stops provide precise control but require adjustment for different price levels. A $2 trail might suit a $50 stock but be inappropriate for a $500 stock.

Key Differences Between Order Types

Understanding the distinctions between these order types helps in selecting the appropriate tool for different situations:

Execution Characteristics

Each order type behaves differently when triggered:

Stop orders prioritize execution over price. During significant price gaps, these orders execute at the available market price, which may differ substantially from the stop price.

Stop-limit orders prioritize price over execution. If the market moves beyond the limit price, these orders may remain unfilled.

Trailing stops combine automatic adjustment with market execution. They adapt to favorable price movements but execute as market orders when triggered, accepting the prevailing price.

When These Orders Are Used

Different market conditions and objectives call for different order types:

Stop Orders Are Commonly Used When:

• Exit execution is prioritized over exact price
• Trading liquid securities with narrow spreads
• Managing risk in volatile conditions
• Positions cannot be monitored continuously
• Entering positions on price breakouts

Stop-Limit Orders Are Often Selected When:

• Price control is prioritized over guaranteed execution
• Trading in normal market conditions
• Managing positions in less liquid securities
• Specific price ranges are acceptable for trades
• The ability exists to monitor and adjust orders

Trailing Stops Are Frequently Employed When:

• Following established price trends
• Protecting accumulated gains
• Managing multiple positions simultaneously
• Removing emotional factors from exit decisions
• Allowing positions room for growth

Stop Order Calculator

This calculator demonstrates how different stop orders function with various parameters:

Common Scenarios and Considerations

Understanding typical scenarios helps illustrate how these orders function in practice:

1. Stop Placement Distance

Setting stops too close to the current price may result in premature triggers from normal price fluctuations. Conversely, stops set too far away may not provide meaningful risk management. The Average True Range (ATR) is often referenced to gauge typical price movement.

2. Gap Risk

Overnight gaps can cause stops to execute at prices significantly different from the stop level. This is particularly relevant around earnings announcements, economic releases, or other scheduled events.

3. Stop Adjustment Discipline

Once set, stops serve their intended purpose when left unchanged. Moving stops away from the market to avoid triggers defeats their risk management purpose.

4. Liquidity Considerations

In thinly traded securities, stop orders converting to market orders may experience substantial slippage. The bid-ask spread and typical volume merit consideration when selecting order types.

5. Corporate Actions

Stock splits, dividends, and other corporate actions may require stop order adjustments. Most platforms don't automatically adjust stops for these events.

Platform Implementation

Trading platforms handle these orders with varying features and limitations:

Order Handling Methods

• Some brokers maintain stop orders on their servers, sending them to exchanges when triggered
• Others route stops directly to exchanges where supported
• Stop order visibility varies by platform and exchange

Time-in-Force Options

Stop orders typically offer these duration choices:

• Day Order: Expires at market close if not triggered
• GTC (Good Till Canceled): Remains active until triggered or manually canceled
• GTD (Good Till Date): Active until a specified date

Extended Hours Limitations

Standard stop orders typically function only during regular market hours (9:30 AM - 4:00 PM ET). Extended-hours stops, where available, often have different execution characteristics and wider spreads.