What Is a Stop-Market Order?

what is a stop market order?

The Balance / Hilary Allison

DEFINITION

A stop-market order is an order to buy or sell if the market price for a stock, security, or commodity hits a set value. It is a type of stop-loss order that is meant to limit the amount of money you can lose on a single trade.

What Is a Stop-Market Order?

A stop-market order is a standing order to sell a security or commodity if the price reaches a certain level. It is meant to protect you from loss if the market moves too far in the wrong direction. These can be orders either to buy or sell, but no trade takes place unless the price hits that trigger. When the price is reached, the stop order becomes a market order.

  • Alternate names: stop-market order, stop order, stop-loss order, stop-loss market order

Successful trading is all about maintaining proper risk/reward, or minimizing your losses and maximizing your gains. Every professional trader has a price in mind for when a trade has gone too far south and they need to get out. Stop-market orders make that threshold official and automatic. This saves you from having to watch the market at all times to curb your losses.

A sell-stop order will be placed below the current market level to prevent too much loss on a sale, while a buy-stop order will be placed above the current market level to grab a stock before it becomes too expensive.

Stop-loss market orders use stop-market orders as their underlying order type. If the market price reaches the designated stop-order price, the order will become "live" and will execute as a market order.

Market orders are always filled if the price reaches the specified level. Because the order won't execute until that point is reached, a market order will always get a trader out of the losing trade. However, market orders are filled at the best available current price. The stop-loss could be filled at any price, not necessarily right at the price you set. When a market is moving quickly, a stop-loss market order may fill or execute at a much worse price than you expect.

How a Stop-Market Order Works

Suppose you buy a stock at $30 and place a stop-market order to sell at $29.90. Eventually, major news is released about the stock. All of the buyers pull their bids from around the $30 region. No one is willing to buy, except at $29.60, where someone still has an order to buy at that price.

Once the price drops below $29.90, your stop-loss market order will seek out anyone willing to buy at $29.90 or below. Since the nearest buyer is at $29.60, that is where your stop-loss market order will fill. In this case, you were only expecting to lose 10 cents per share but instead lost 40 cents. This is called "slippage." It's a common issue with any type of market order.

Slippage is less likely to occur if you avoid day trading volatile assets or ones that have very low volume. It's also wise to avoid holding positions during major news releases related to the asset you're trading, as such news events can cause significant slippage.

Although slippage can lead to more significant losses than you hoped, the market order still gets you out of your position and protects you from further potential losses. Slippage doesn't occur all the time. Under normal conditions, a stop loss market order will get the trader out at the price expected.

Stop-Market Orders vs. Stop Limit Orders

Stop-Market Order Stop-Limit Order
Only executes if the market reaches the stop price or worse Only executes when the market hits the stop price but stays better than the limit price
Will always execute if the market hits that price or worse Will not execute if either condition is not met
Good for stopping further losses on a trade May not prevent major losses on a trade
Losses can be larger than you expect Good strategy if you expect the price to bounce back, but risky

Stop-loss limit orders are stop-loss orders that use limit orders as their underlying order type. Stop-limit orders usually use two different prices—the stop price and the limit price. The order does not become active on the market until it reaches the stop price, at which point the limit order becomes active.

Limit orders are only filled at the order price (or at a better price if one is available). Because the market may move in the opposite direction, limit orders are not always filled. That means the stop-loss limit order may not get you out of a losing trade. When a market is moving quickly (or if a market has a large bid-ask spread), a stop-loss limit order can remain unfilled indefinitely, which exposes you to potentially larger and larger losses. In some cases, though, it may save you some money.

For example, suppose you buy a stock at $27 and place a stop-loss limit order with a stop at $26.50 and a limit at $26. The stop order will become active if the price drops below $26.50, and it will sell as long as the market is above $26.

Suppose a big sell order enters the market, absorbing all the buy orders all the way to down to $25. Your order is now live because the price dropped below $26.50. But it will not execute until the price again reaches the limit price of $26. A few moments later, the price may bounce back up to $26, getting you out at the minimum price you desired. If the stop-loss were a market order, it would have taken any price it could get, getting you out at $25. If the market goes back up, the limit order may have saved you $1 per share.

However, that only works if the price comes back to the stop-limit order price. If the price keeps going the wrong way, using a stop-limit order won't get you out of the trade. In that case, the loss on the trade will mount. In the above example, if the price drops to $25 without filling your stop-limit order and keeps dropping, you may face indefinite losses. 

Do I Need a Stop-Market Order?

In general, stop-loss orders should be market orders. The entire point of a stop-loss order is to exit a trade. A stop-market order is the only type of order that will always make this happen. The extra losses that are caused by slippage are minor, compared to the potential loss that can arise from an unfilled stop-limit order. You often can avoid slippage by trading high-volume assets and not holding positions during major news events.

Stop-limit orders can be helpful, though, if you have patience and are confident that a stock price will go back up. When prices are moving quickly, some traders would rather wait it out than accept a sudden large drop in price. If you're willing to accept the risks, this can be an effective strategy.

Key Takeaways

  • A stop-market order, also called a "stop order," is a type of stop-loss order designed to minimize losses in a trade.
  • Stop-market orders become market orders as soon as the stop price is met and will execute at whatever the prevailing market price is.
  • These orders will always get you out of a losing trade, but your losses can be larger than you expect.
  • Another type of stop-loss order, the stop-limit order, is more complex and risky but can limit losses if the market price rebounds.

Frequently Asked Questions (FAQs)

What is a buy stop order?

A buy stop order can refer to two different uses of a stop-market order. A stop order can be used to buy stock and start a trade when the price drops to the stop level. A buy stop order can also be used to close a short position. In that case, the order will buy-to-close at the market price when the price rises to the stop level.

What is a trailing stop order?

A trailing stop order is similar to a stop-market order. There's one twist with a trailing stop order: the stop level can move in your favor. Instead of being set at a specific price, a trailing stop level is set compared to the current price.

For example, a trailing stop order to sell a long position could be set to trigger when the price drops by $1. If the stock starts at $50, the initial stop level is $49. If the stock price rises to $55, then the stop level rises to $54.

Article Sources

  1. U.S. Securities and Exchange Commission. "Stop Order." Accessed Dec. 11, 2021.

  2. U.S. Securities and Exchange Commission. "Trading Basics," Page 1. Accessed Dec. 11, 2021.

  3. AVA Trade. "What Is Slippage?" Accessed Dec. 11, 2021.

  4. U.S. Securities and Exchange Commission. "Trading Basics," Page 2. Accessed Dec. 11, 2021.