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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

  • "mitigate" means "reduce somewhat". Putting "mitigate" with "all" is a bit of an oxymoron. – Acccumulation Jun 20 '18 at 22:22
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    The only way to "guarantee the loss of $10" is to buy a put with a slightly higher strike price where the distance from $100 to the strike price plus the premium paid for the put equals $10. If you don't like the out of pocket costs for puts and if you are familiar with covered calls and you are comfortable with giving up most of the upside profit potential above a certain price, then sell a covered call to fund the cost of the protective put. In this case, it might be a $110 call. This is called a collar and your guaranteed P&L zone is $110 to $90 (strikes used can be wider or narrower). – Bob Baerker Jun 21 '18 at 11:22
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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.

  • I would change most to some. The problem with selling, is when to rebuy. After a stop loss is triggered you are now faced with the nearly impossible decision on when is the right time to buy. – Pete B. Jun 20 '18 at 16:44
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    I see your point. If I'm selling a stock, though, I'm done with it, not looking to rebuy. But OP might be a trader. Easier would be to buy stocks that you can forget about for the long term! Can't remember the last time I bothered to have a stop order. – Rocky Jun 20 '18 at 17:18
  • Even in that case @Rocky. What do you rebuy? When do you rebuy it? Is this stock down because the market, as a whole, is going lower? I even think "some" is a bit optimistic. – Pete B. Jun 20 '18 at 18:02
  • What happens with gaps ? if There is some bad news when stock market closed and upon reopen and gaps down (two red candles with a gap and that is where I placed my Stop). when would it trigger. I'm looking at high volume stock like Amazon, Netflix – Orange Juice Jones Jun 20 '18 at 18:18
  • There is no way to know when it is the right time to buy because the future is unknown. The process for rebuying a stock is no different from what you did when you initially bought any stock in your portfolio. On that day, you thought that the current price was a good value. There were no guarantees that you were right. – Bob Baerker Jun 20 '18 at 22:59
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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.

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    Buying a protective put is a viable way to insure that you have a guaranteed exit price. Like all insurance, it's a total waste of money (and a drag on performance) unless you need it. Legging into the position to protect equity value is one thing but if considering opening the combo position simultaneouly (buy stock and buy put at the same time) then just buy the call since the positions are equivalent and doing the latter will save on frictional costs, commissions and the margin requirement, if utilizing margin. – Bob Baerker Jun 20 '18 at 23:04
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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.

  • ' because others may be in the order book in front of you' - As gaps usually happen in the time of market opening, suppose we all hear about some bad news overnight - how do other orders get in front of mine? Would I need to change my stop loss to a market order before the market opens? – Orange Juice Jones Jun 21 '18 at 8:11
  • @Raj Chahal - (1) They are one and the same. When the price of your stop loss order is hit, it becomes a market order and the fill may be worse than the stop loss set. (2) If 10 people place a stop loss order to sell at $90 before you place your stop loss order at that price then all of their shares will be filled before your order is executed, assuming that there is sufficient buying volume to match their orders. If not, price drops and you'll get less than $90. – Bob Baerker Jun 21 '18 at 11:14
  • So the person who sets the stop loss sooner (in time) gets serviced earlier? – Orange Juice Jones Jun 21 '18 at 13:15
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    Orders are prioritized according to price and time. If the price of more than one order is the same: (1) Priority: The order that was received first gets filled first (2) Precedence: If the time and price are the same, the larger order gets filled (3) Parity: If all conditions are the same, the orders are matched in the crowd and the shares are split among the orders. Also, read: quant.stackexchange.com/questions/2278/… – Bob Baerker Jun 21 '18 at 13:59

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