Do stop-loss orders actually stop losses?
Or the same as SNB case : when people found their accounts in red (not at 0, in red)
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There are a lot of ways to manage risk in a portfolio. All have pros and cons. One often misunderstood tactic is to employ stop orders
Q. I like a stock and want to buy it, but the markets have me a little nervous. A friend suggested a stop-loss order would protect me from a big loss. I don't hear many people talking about them. How do those work exactly?
A. You may not hear about them much because they can be a pain in the neck and often fail as a loss-protection mechanism.
A stop-loss order is an order that instructs a brokerage to sell a security, usually a stock or an exchange-traded fund, when the security reaches a certain price. For example, you own shares of ABC which are currently selling for $50/share and place a stop-loss order at $45/share. You may think you have a maximum loss of $5, but that is not necessarily the case.
A stop-loss can fail as a loss limitation tool because hitting the stop price triggers a sale but does not guarantee the price at which the sale occurs. We see this often when the stock opens at a substantially lower price, but it can happen intraday as well. It doesn't really matter why ABC opens lower, but if it opens at $40, the sell order is triggered, and ABC will be sold at the prevailing market price, not $45. That could be more or less than $40.
To combat this, you can place a "limit" on the stop-loss by which you will sell for no less than the limit price. The limit however, does not guarantee a sale either. In our example, if the limit was set at say $44, the stop would have been hit, but with ABC opening at $40, the limit would have prevented a sale until the price rose to $44, if it ever did.
Without the limit, you sold at $40. With the limit, you didn't sell at all. Either way, the stop-loss order didn't get you out at $45.
Are you investing in the stock or trading in it? For long-term investors, limiting losses is often better accomplished by a more conservative portfolio structure to begin with. Such investors are typically diversified enough that the fate of an individual stock is not critical to their success, and they will own safe stable investments to offset the natural volatility of stocks.
Don't get me wrong. Stop-loss orders are not useless, by any means. They just aren't as much of a sure thing as they are often described or thought to be.
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