I would like to know how I can protect against a stock price falling. If a stock price is at $100 and I put a Stop Market order at $90, then will this always execute at this price so I can guarantee the loss of $10. What would happen when the stock gaps ? (btw does gaps happen only at time of day opening?) Bit of a newbie so hope I've provided all information to answer this question. Thanks
Not all risk, but often most risk -- keep in mind that in a stock market trade, there must be a buyer for every share you sell. With a large-cap stock that has a lot of daily volume, it's just about never a problem. With OTC penny stocks, however, you might not find a buyer at your stop loss and the price could keep falling and you'd end up selling lower.
Also keep in mind that the stop loss can and will be triggered if the price falls even temporarily! So if you place the stop loss just a bit below current market, for example, you might end up accidentally triggering and selling.
Definitions: a stop-loss will eventually execute but cannot guarantee price. A stop-limit can guarantee price but not execution. Think of it this way: when the stop price occurs, your order is either placed as a market order or a limit order.
In the end, the market is made by buyers and sellers. A Stop Market order at $90 means that you are offering to be a seller as soon as the price drops under $90. But there is no guarantee that there will be (sufficient) buyers at that price.
Buyers might disappear for any reason, including a large seller showing up and satisfying current demand.
If you want to be certain that you can sell at $90, that can be arranged - at a price. The method is a put option. If you buy a put option at a strike price of $90, you have the right to (typically) sell 100 shares at $90, regardless of the market price. That's not a very valuable right while the stock is priced at $100, but it becomes quite valuable when the stock hits $80. Think of it as insurance.
Since a Stop Limit order has a limit price for the order's execution, a $10 loss limit might not be executed if your the stock gaps below $90.
A Sell Stop order will trigger a market sell order if price drops $10. There is no guarantee that you will be filled at $90 because the stock may gap through $90 and open at a far lower price. And even if the stock dropped exactly $10 to $90, there's no guarantee that you will be filled at $90 because others may be in the order book in front of you, buyers will take out some but not all of them at $90, and then price will drop and your fill will be lower.
As a worst case scenario, suppose your $100 stock has traded down to just above $90 and then it gaps down through your $90 Stop Order. Down almost 10% plus the gap. Not pretty.
As for this almost never happening with large-cap stocks with a lot of daily volume, that's not true. Even rock solid Dividend Aristocrats have had 10% down days. Some examples include TGT, WMT, CAH, GWW. It's not an uncommon occurrence, particularly when quarterly earnings are released.
A classic large-cap horror story example is Valeant Pharma which had 11 drops of more than 10% in less than 4 months with the worst one being down 50+ pct. The gap that day was -23% so that would be your best case scenario though not necessarily your actual loss. It could have been more in a fast market and most likely was.
Today's horror show was Anika Therapeutics (ANIK) which announced a failed phase 3 clinical trials study yesterday just after it closed at $46.12. The stock was halted and when it opened around 4:30 PM, the first trade was 100 shares at $32.00, closing today at $28.77 (down $17.35). How safe was a 10% stop loss order on this one?
Gaps are most common in the morning when the market reacts to overnight news, though they can occur at any time of the day.