What Is a Stop Market?

Definition & Examples of a Stop Market

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A stop-market order is a type of stop-loss order designed to limit the amount of money a trader can lose on a single trade. It can be an order to buy or sell, and it will only trigger if the market price for that stock, security, or commodity hits the specified level. When a market moves quickly, the final price of the trade could be worse than the price set in the stop-market order.

Since successful trading is all about minimizing losses and maximizing 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 save you from having to watch the market constantly to curb your losses. Let's look at how these market orders work, and compare them to another important type of stop-loss order, the stop-limit order.

What Is a Stop-Market Order?

A stop-market order, often simply called a stop-loss order, is meant to protect a trader from loss if the market moves too far in the wrong direction. It sets up a trigger price at which the order to buy or sell takes place. No trade takes place unless the price hits that trigger.

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 execute as a market order.

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

  • Alternate name: Although a stop-market order is just one type of stop-loss order, "stop-loss order"—or simply "stop order"—is often used to refer to a stop-market order.

How a Stop-Market Order Works

Let's assume you buy a stock at $30 and place a stop-market order to sell at $29.90. Major news is released about the stock, and all 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, and 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. Also, 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-Limit Orders

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 the trader 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, exposing the trader to larger and larger losses. It can also, on occasion, save the trader some money.

How a Stop-Limit Order Works

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

Imagine 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, and the loss on the trade will mount. In the above example, if the price drops to $25 without filling your stop-limit order, and then keeps dropping, then you may face indefinite losses. 

Stop Market vs. Stop Limit

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 market hits that price or worse Will not execute if either of those conditions is not met
Good for preventing further losses on a trade May not prevent major losses on a trade
Losses can be larger than anticipated Good strategy if you expect the price to bounce back, but risky

Which Type of Order Should I Use?

In general, stop-loss orders should be market orders. The entire point of a stop-loss order is to exit a trade, and a stop-market order is the only type of order that will always accomplish this. The additional losses that are incurred from slippage are minimal compared to the potential loss that can arise from a trade that is not exited at all (due to an unfilled stop-limit order).

In addition, slippage can typically be avoided by trading high volume assets, and not holding positions during major news events. While you can usually minimize slippage, the problem of a stop-limit order not filling can be much more serious—especially if you are not at your computer to get out of the trade if the loss keeps mounting.

Stop-limit orders can be helpful, however, if you have the patience and confidence that a stock price will rebound. 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 then execute at whatever the prevailing market price is.
  • These orders will always get you out of a losing trade, but losses can be larger than expected.
  • Another type of stop-loss order, the stop-limit order, is more complex and risky but can limit losses for patient traders.

Article Sources

  1. U.S. Securities and Exchange Commission. "Stop Order." Accessed June 17, 2020.

  2. U.S. Securities and Exchange Commission. "Trading Basics." Accessed June 17, 2020.

  3. Charles Schwab. "Mastering the Order Types: Stop-Limit Orders." Accessed Jue 17, 2020.