The Many Flavours of Stop Orders

To many people a stop order looks like a very simple thing, represented as it often is by a single input box labelled “stop” on a spread bet trading ticket. The purpose of a stop order is also regarded by many as very simple: to stop a loss. Yet stop orders are not as simple as they first appear, and they come in many flavours as follows.

The Stop Order To Sell

The most familiar stop order to sell is designed to execute sometime in the future when the price of a financial instrument falls to a level that you specify. This kind of stop order may be attached to a specific long trade, in which case its purpose may be to stop a loss or secure a profit. Alternatively, it might be a standalone stop order that opens a new short trade when a price begins to fall.

The Stop Order To Buy

The less familiar stop order to buy is the mirror image of the stop order to sell, and it is designed to execute sometime in the future when the price of a financial instrument rises to a level that you specify. This kind of stop order will likely be used to open a new long position when a price starts trending upwards, but it might also be attached to a specific short position as a mechanism for stopping a loss or securing a profit on that short position.

The Trailing Stop Order

The trailing stop order allows you to specify a stop distance rather than a stop level, thereby allowing you to lock-in even more profit or suffer less and less loss as the price goes the way you want it to. Theoretically (though usually not offered in practice) a trailing stop order could even help you to enter a position at an increasingly better price as I explained in my article on the TRAILING STOP BUY.

The Guaranteed Stop Order

A guaranteed stop order (which you usually have to pay for) guarantees the price at which you will stop out in the event of a market price gap. It allows you to transfer the risk of stopping out unfavourably — which can happen, because stop orders usually “guarantee execution but not price” — to the trading platform provider. Use a guaranteed stop order if you can’t afford the risk.

The “Good Until” Stop Order

Many trading platforms allow you to specify a stop order that is “good until” a particular time. You might want your stop order to stop you out of (or into) a position only if it can be done within the trading day, or within a month, rather than defaulting to the indefinite good till cancelled.

Other Favours of Stop Orders

Depending on the instruments you’re trading, and the platform on which you’re trading them, you might find that other flavours of stop orders are made available to you; like the one-cancels-other (OCO) kind that allows you to hedge your bet on which way you think the market will go, or the stop-with-limit kind which acts as a substitute for guaranteed stop orders on some stockbroker trading platforms.

Can’t Find Your Favourite Flavour?

The kinds of stop orders vary from platform to platform, and you might not be able to find the flavour you want on your platform. In some cases you might want to switch to another platform, and in some cases you might prefer to create your own flavour manually. For example: you can implement your own trailing stop order by manually adjusting the level of your non-trailing stop order periodically, or you can make your stop order “good until” simply by making a note in your diary to remove it when you feel that it has outstayed its welcome. Indeed, some people employ a novel “time stop”, by which they stop out of a position manually if the price goes nowhere within a specific period of time.

Mixing Up The Flavours

I use the word “flavours” rather than “types” of stop orders because we’re talking about properties of stop orders that are not mutually exclusive. For example: it is possible, though not on all platforms, to mix up the flavours to create a stop order that is to sell, trailing, and guaranteed to be good until a time of your choosing.

And you thought stop orders were simple one-dimensional mechanisms for merely stopping a loss. Think again!

Tony Loton is a private trader, and author of the book “Stop Orders” published by Harriman House.