Stop loss: what it is and how stop orders work

Written by the Tactfolio research teamPublished Data as of 6 min read

A stop loss is an order to sell a stock once its price falls to a level you choose, called the stop price. When the price reaches that level, the order turns into a market order and sells at the next available price. It can limit a loss, but it does not lock in the stop price, and a price gap can fill you much lower.

Key points#

  • A stop-loss order (also called a stop order) sells when the price touches your stop price.
  • Once triggered, it becomes a market order. The sale price can be well below the stop.
  • A stop-limit order sets a lowest price you will accept. It protects the price but may not sell at all.
  • A trailing stop moves up as the price rises and stays put when it falls.
  • Short dips can trigger a stop and sell you out right before a rebound.

In health insurance and the military, “stop-loss” means something else. This page is about stock trading.

What is a stop loss order?#

A stop-loss order is an instruction to your broker to sell once a stock trades at or below a set price. The SEC’s investor site, Investor.gov, describes it this way. When the stop price is reached, the stop order becomes a market order.

A market order is an order to buy or sell right away at the best price available. It is sure to fill, but the price is not set.

Investors use a sell stop to try to limit a loss, or to protect a gain, on a stock they own. It is an exit tool, often paired with an entry rule built on one of the best indicators for trading. The order waits at your broker until the price is reached, so you do not have to watch the screen all day.

Stop vs stop-limit vs trailing stop#

The three orders differ in what happens once the price is hit.

OrderWhat it does once triggeredMain risk
Stop (stop-loss)Becomes a market order and sells at the next priceCan sell far below the stop in a fast fall
Stop-limitBecomes a limit order that sells only at your limit or betterMay not sell at all if the price drops past your limit
Trailing stopA stop whose trigger follows the price up by a set amount or percentA normal dip can trigger it

A limit order sells only at a set price or better. Investor.gov gives an example of a stop-limit: a stop of $3.00 with a limit of $2.50. The order goes live at $3.00 but can only sell at $2.50 or higher.

Brokers also differ on what triggers a stop. Some use the last trade price. Others use quotes. Ask your broker which one it uses.

A stop loss example with round numbers#

Say you buy 100 shares at $50, or $5,000. You place a sell stop at $45. You are willing to lose about $500.

A slow slide. The stock drifts down: $48, $46, $45. At $45, your stop becomes a market order. It sells at about $45, or a bit lower. Your loss is about $500, as planned.

A gap down. The stock closes at $47. Overnight, the company reports bad news. The next morning, the stock opens at $40. Your stop triggers at the open and sells near $40. Your loss is about $1,000, twice what you planned.

A gap is a jump between one day’s close and the next day’s open, with no trades in between. Our guide to the stock gap explains why gaps happen.

The same gap with a stop-limit. Now say you used a stop at $45 with a limit at $44. The stock opens at $40. Your order becomes a limit order to sell at $44 or better. No one will pay $44, so it does not sell. You still own the shares at $40.

Neither order is wrong. A stop gives up price to make sure you get out. A stop-limit gives up the sure exit to protect the price.

How a trailing stop works#

A trailing stop sets the stop a fixed amount or percent below the market price. When the price rises, the stop rises with it. When the price falls, the stop stays where it is.

Investor.gov uses this example. You buy a stock at $20, and it rises to $22. You set a trailing stop $1 below the market. The stock peaks at $24, so your stop climbs to $23. Then the price drops. The stop stays at $23, and the shares sell when the stock reaches $23, though the sale price may differ.

Do stop losses work?#

Stop losses limit how much one trade can lose in a slow decline. Whether they help over time depends on how prices move.

Kathryn Kaminski and Andrew Lo studied this in When Do Stop-Loss Rules Stop Losses? in the Journal of Financial Markets (2014). If prices move at random, they showed, a simple stop-loss rule always lowers expected return. If prices have momentum, a stop-loss rule can add value. Momentum is the tendency of a falling price to keep falling for a while, or a rising one to keep rising.

So a stop is mainly a way to manage risk. It gives up some return to cap how much one trade can lose, and a gap can break that cap. Rules that exit when a trend turns down, known as trend following, rest on the same momentum idea.

Common mistakes#

  • Setting the stop too tight. A stop 2% below the price on a stock that moves 3% a day will trigger often.
  • Thinking the stop price is locked in. The stop price only starts the sale. Gaps and fast markets can fill lower.
  • Moving the stop down. Lowering a stop as the price falls defeats its purpose.
  • Using a stop-limit and forgetting it. In a crash, a stop-limit can sit unfilled while the price keeps falling.
  • Stops on thinly traded stocks. Few buyers means a market order can fill far from the last price.

Try it on Tactfolio#

Tactfolio stock and ETF strategies run on daily closes and do not place stop orders. The closest idea is a rules-based exit, checked once a day. For example, the 200-day moving average strategy holds the S&P 500 above its 200-day average and moves to Treasury bills below it. As of September 25, 2026, its hypothetical backtest from mid-2007 had a worst fall of about 22%, against 55% for the S&P 500. It also returned less, about 8% a year against 11%. A moving average is the average closing price over a set number of days.

In the strategy builder, a condition can also compare a fund’s price with its highest close over a window you choose. That works like a trailing stop checked at each close. It still cannot avoid an overnight gap.

Common questions#

What is a stop-loss order in simple terms?#

It is an order to sell a stock if the price falls to a level you set. Once that price is hit, the order sells at the next available price. It helps limit a loss without watching the market all day.

What is the difference between a trailing stop and a stop loss?#

A regular stop loss stays at one fixed price. A trailing stop follows the price up by a set amount or percent and stays put when the price falls. Both turn into market orders when triggered.

Can a stop loss fail?#

Yes. If the stock gaps below your stop, the order sells at the next price, which can be much lower. A stop-limit order avoids that, but it may not sell at all.

Where should I set my stop loss?#

There is no single right level. Many people set it based on how much they can afford to lose, and on how much the stock normally moves in a day. A stop inside the stock’s normal daily range will trigger often.

Do stop-loss orders work after hours?#

That depends on your broker. Investor.gov notes that not every firm offers every stop order type, and rules differ by firm. Ask your broker how it handles stops before the open and after the close.

Sources

Put it into practice