Stop loss orders – orders where you tell your broker to buy or sell a specific stock when price reaches a predetermined level – can be a great resource, most of the time. However, there are certain situations in which stop loss orders won’t necessarily help you. Before you execute a stop loss strategy you should know what these situations are, so that you can avoid them and react accordingly.
Listed below are 5 situations when your stop loss order won’t work correctly:
- The stock price is lower than the bottom price.
- The market is extremely volatile.
- You assume you can completely predict price movements.
- You aren’t watching your portfolio closely.
- The limit price is too close to the stop loss price.
Beyond doubt, you can take some of the risks away by using a stop loss system – as long as you use it right. But, stop loss isn’t perfect. So, you must monitor your portfolio when you can. If you want to learn more about these situations where a stop loss order may fail you, make sure to continue reading!
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5 Situations in Which a Stop Loss Order Fails and Doesn’t Work
Described below are five situations in which a stop loss order does not fully work as expected:
1. The Stock Price Is Lower Than the Bottom Price
While stop loss orders are a great resource, you still need to use them carefully. When the market moves quickly, it may not work as intended.
The stop loss may not activate when the stock price is lower than the bottom price that you set.
When the price drops too quickly, the stop loss might not trigger – which can put you in a challenging position.
This happens because the system might not recognize that the stop loss point occurred before the bottom price, or limit order, arrives. That means your broker won’t be able to sell the stock (due to your limit order settings) and the stop loss goes ignored.
2. The Market Is Extremely Volatile
It’s also best to watch the market when it’s incredibly volatile. In such market conditions, the stop loss order might not come into effect. If that were to happen, you would expose yourself to a continuously dropping stock price.
The best way to continue using your stop loss settings with a volatile market is to set up a stop limit. While having a limit price does help, it doesn’t completely take out all the risks associated with a volatile market.
Volatility means the market rises and falls without much rhyme or reason. When you notice your stock behaving in this way, you must know how to research it. You might need to adjust any stops or limits that you placed on the stock.
3. You Assume You Can Predict Price Movements
One of the most common reasons a stop loss order fails is that the investor based their prices on previous stock prices. It’s essential to keep in mind that stock prices in the past don’t indicate what future movements will be.
Many people use stop losses like they can predict the price changes, when in fact, they can’t. Instead, you need to set the stop loss on your account according to what you’re comfortable with. It would be best to use it to reduce the losses you might experience- base the prices on what you don’t want to risk.
4. You Aren’t Watching Your Portfolio Closely
Additionally, many investors have a bad habit of ignoring their portfolio once they’ve set the stop loss prices. When you do this, you could miss out on better selling prices since the platform should sell as soon as it reaches your setting – it could always go over that amount. (This is more of an issue when you are using stop loss orders to capture profit.)
When you’re not paying attention to your portfolio, you put your assets at risk. If you check in on your stock from time to time, you may notice the stop loss not executing, allowing you to take action as needed. Doing so reduces some of the loss you might’ve experienced otherwise.
Overall, the stop loss method does not allow you to “set and forget.” You’ll still need to check in on it from time to time, possibly adjusting the limit while you’re at it.
5. The Limit Price Is Too Close to the Stop Loss Price
Finally, keeping the limit price close to the stop loss price can cause the order not to execute. While you should always set limit prices, you don’t want them to be too close together.
If the price were to drop rapidly with the limit and stop loss close in price, it could drop below the limit without taking action. Overall, this could lead to a heavy loss on your end.
To have your order go through every time, you want to make sure the stop limit and stop loss price are at least 20% apart. You can place them further apart if you think it’s a good idea for your unique situation.
How to Effectively Use Stop Loss Orders?
Luckily, there are only few situations where your stop loss order can fail. Many investors use these tools to help keep their trades under control. You can quickly minimize the risks of a failed stop loss by knowing what to watch out for.
To avoid situations where the stop loss doesn’t work, you’ll need to understand what it is and how it works. From there, you can choose the price settings that make the most sense for the type of stock that you’re trading.
Overall, stop loss orders aren’t perfect! You’ll need to be somewhat active in monitoring them so that they can work to their fullest.
How Stop Loss Orders Work?
According to Investopedia, stop loss orders are triggers that you tell a broker to watch for. When one occurs, the broker takes the actions that you previously specified. It’s a helpful way to control your portfolio when you can’t be there to watch it. Plus, it’s an excellent method to navigate some of the risks that come with trading.
Stop losses, or limits, are in place to limit your losses. If you set a stop loss order for 10% below the price you bought the asset, the limit prevents your loss from being more than 10%. Overall, it’s useful for most investors.
Like many tools, if you misuse it, the stop limit won’t work as intended- costing you! You’ll need to make sure you take steps to prevent this from occurring.
Do Professional Investors Use Stop Losses?
If you’re working on becoming a professional trader, you might want to learn what others do. Often, beginners wonder if the pros also make use of stop losses.
Both professional investors and beginners use stop losses. This is because setting limits helps investors hedge some of their risks. Additionally, many firms today require that their traders employ stop losses to lessen risks. However, they also update the prices often.
In short, stop losses serve as a useful part of your investment strategy, no matter whether you’re just starting out or have been investing for decades. These stock tools can take some getting used to, but it’s worth it to ensure your settings don’t fail you. If you keep track of the above situations, you should put yourself in a position to succeed.
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Conclusion
There are a few different situations where you might experience issues with your stop loss orders, including situations in which the market is extremely volatile. You should make sure to check the settings on all your accounts so that you can reduce some of the risks you take on and limit how much money you lose.
Overall, stop loss orders are an effective tool – as long as you use them correctly. You should take time to familiarize yourself with how they work before implementing them in your strategy, and it’s always a good idea to check your portfolio from time to time!
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