What is a Stop-Loss Order and How Does it Work?

A stop-loss order allows us to set a price called the ‘stop-loss price’ of a stock or a share. This is a value the investor chooses, at which they will sell it to minimize their loss on the investment.

When the price of the stock hits the stop-loss point, the stop-loss order is triggered and it turns into a market order to sell at the current market price.

For example, let’s say an investor has 100 shares in ABC Inc., and the current price is $40 per share. The investor wants to sell the stock if the market price falls to or below $36, in order to limit their loss.

The diagram above illustrates how a stop-loss order is executed by a trading system.

Stop-Loss Order Execution

• The investor submits a stop-loss order to the trading system with 100 shares, to sell for $36.

• Upon receiving the order request, the trading engine creates the stop-loss order.

• The trading engine subscribes to the market data of ABC Inc. from the exchange and monitors its real-time market price.

• If the trading engine detects that the market price of ABC Inc. falls to, say, $35, it immediately creates a market order and then submits it to the exchange to sell the 100 shares for the current best market price.

• The order is filled (i.e. matched to the best buy orders in the market,) usually instantaneously. Then the trading engine receives from the exchange a ‘fill report’ stating the shares have been sold for, say, $35.5 per share.

• The trading system notifies the investor that the 100 shares have been sold for $35.5 per share.