Legal Definitions - stop-loss order

A stop-loss order is an instruction given to a broker to sell a security (like a stock or a bond) once its price falls to a specified level, known as the "stop price." The primary purpose of a stop-loss order is to limit a potential loss on an investment or to protect accumulated profits from a significant downturn. Once the market price reaches or falls below the stop price, the stop-loss order typically converts into a market order, instructing the broker to sell the security at the best available price.

Here are some examples illustrating how a stop-loss order works:

• Protecting Investment Gains: Imagine Sarah bought shares of "Tech Innovations Inc." at $60 per share, and the stock has since risen to $95 per share. While she's pleased with the profit, she's concerned about a potential market correction that could erase her gains. To protect her profits, Sarah places a stop-loss order at $85 per share. If the stock price of "Tech Innovations Inc." drops to $85 or below, her shares will automatically be sold, ensuring she locks in a significant portion of her profit and limits her potential loss from the peak price.

• Limiting Risk on a New Investment: David decides to invest in a promising but volatile startup called "Future Energy Solutions" at $120 per share. He believes in the company's long-term potential but wants to cap his downside risk in case the venture doesn't pan out as expected. To do this, David places a stop-loss order at $105 per share. If "Future Energy Solutions" stock unexpectedly declines due to poor performance or market sentiment and hits $105, his shares will be sold, preventing his loss from exceeding $15 per share from his initial purchase price.

• Automated Portfolio Management: Maria is a busy professional who manages her own investment portfolio, which includes several different stocks. She cannot constantly monitor every stock's performance throughout the trading day. For her holding in "Global Logistics Co.," currently trading at $70 per share, she sets a stop-loss order at $63. This means that if unforeseen negative news or a sudden market downturn causes "Global Logistics Co." stock to drop to $63, her shares will be automatically sold. This mechanism helps her manage risk across her portfolio without requiring her constant manual intervention, acting as an automatic safety net against significant losses.