The Scoop on Stop-Loss Orders

Are you worried that the stock market has topped out and is overdue for a fall? A good way to prevent your stock portfolio from sliding back to the lows of last March is the stop-loss order. A stop-loss order tells your broker to sell a stock when it reaches a pre-determined price. As its name implies, a stop-loss order is designed to prevent you from taking a loss on your stocks, but it’s also useful for locking in profits.

Here’s an example: Your stock in ABC Company hit a low of $60 a share several months ago. Now, it’s up to $90 and you don’t want to take the risk that it might take another big fall in the near future. So you give your broker a stop-loss order to sell the stock if it goes down to $85, preserving a $25 per share recovery. Another benefit -- you get to relax because you no longer have to track your stock’s price every day. If the stock continues to go up, you can use what’s known as a trailing stop-loss order, which pegs the sell price at a set percentage below the stock’s current price level.

There are some downsides. Stop-loss orders don’t work well with volatile stocks — sharp rises and dips in price may just end up losing you money in commission fees. It’s also important to realize that once the target price is reached, the stop-loss sell order become a market order; if a stock is in free-fall, your selling price may be much lower than the your stop-loss price target.