Stop loss

A stop loss trade is one that is made in order to set a limit to the loss made by an adverse price movement.

For example, an investor who buys a share at 100p may decide to sell if the price falls below 80p so that the maximum loss will be 20p per share (or 20% of the amount invested) plus trading costs.

It is possible to enter limit orders that execute when the price reaches certain levels, thus automating the stop loss process. An investor then does not have to keep checking security prices, merely choose a stop loss price and enter a limit order.

One problem is that there is no guarantee that it will be possible to sell at the stop loss level. If a share price collapses suddenly it may only be possible to find buyers well below the stop loss price.

A stop loss transaction need not be a sale as short selling losses can be limited by a stop buy.

Market crashes can be exacerbated by the widespread use of stop loss strategies, in particularly where the trades are automated.