What to Do if Your Broker Ignores Your Stop Loss Order
If your financial advisor ignores your instructions to place a stop loss order, do you know what to do? A Stop Order is an order to sell a security if its price reaches a certain value, called the “stop price.” If the stock price falls to or below this price, then the stop order automatically triggers an order to sell.
This is the quickest way to exit a trade, and trades occur at the next available price. The price at which the sale is executed is often not the same as the stop price.
What is a stop limit order?
Stop Limit Orders function the same as a Stop Order, except that in a Stop Limit Order you set a limit price, which is the lowest price you are willing to accept for a security.
For example, let’s say you have a stop order on the stock XYZ for $190, but the limit at which you’re willing to sell is $185.
It works like this:
Stop: $190 — when the stock hits this price, then sell.
Limit: $185 — but don’t sell if it is currently lower than $185.
Let’s imagine the stock closes at $200. But then some catastrophic after-market news causes it to crash to an unprecedented $183. Although this is lower than your stop price—$190—it is also lower than the limit you’re willing to sell the stock at—the limit price—so the market order will not execute until the stock rallies to at least $185.
Pros and cons of stop orders versus stop-limit orders
Stop orders will allow you to exit a position immediately, but might leave you at a disadvantage if the price rises again shortly after. Stop orders ensure that trades are executed, but offer no guarantee on price. In volatile markets, they can lead to large unexpected losses.
Although stop-limit orders prevent this scenario, they have the reverse liability of forcing an investor to hold onto a crashing security that shows no signs of rallying. The resultant losses can also be immense.
In volatile markets, sudden drops in prices—called “gaps”—can sometimes occur. The price sinks and then recovers. If a stop order is in place, it can trigger a sale at the lower price when it was only a temporary market fluctuation.
The same is true for price differences that occur between regular market sessions—anything occurring after 4:00 PM and before 9:30 AM Eastern Time for the NYSE. If bad market news causes a sudden drop overnight, a stop order could be triggered when the market opens. But that price could rally again after trading begins.
Stop orders versus manual management
Stop orders can be useful for people who don’t have the time to constantly monitor stock positions. But it’s important to know that when the stop price of a stop order is reached, it becomes what is called a “market order.”
A market order is an order to buy or sell a security immediately. But this does not guarantee that the trade will occur. Every sale needs a willing buyer. Stop orders, once they become market orders, will remain active until the sale is executed, even if the sale occurs at a much lower point than the stop price.
For inexperienced, risk-averse investors, the idea of stop orders might sound like a good one. But they can lead to tragic consequences, as occurred in this story of a 59-year-old military vet who lost $12,000 when the stocks he held dropped 38 percent, triggering the stop order, only to bounce back up again after he had sold. He then placed a second stop order to prevent further losses, but late news caused the market to open at an even lower price, triggering a second catastrophic sale.
Ensuring that investors understand the potential consequences of stop orders is a key recommendation made by FINRA.
Too many concurrent stop orders can contribute to further market decline
FINRA recommends educating investors that the concurrent execution of many stop orders might further drop the market price. Not only does this contribute to overall market volatility, but it also increases the risk to the individual that their execution price will be much lower than their stop price as a result of the market’s descent caused by a flurry of selling.
Sometimes, advisers might suggest that investors set their stop prices fairly high. Under certain circumstances, the lower the stop price, the more likely that the market is already in precipitous decline, which heightens the chances of that investor’s execution price ultimately being lower. But every security and case is different, and investors should seek the advice of their registered financial advisers on the matter of what stop price is the best for them to use.
Financial adviser and broker responsibilities regarding stop orders
Registered FINRA members are required to take effective action to educate investors regarding stop orders. This education must inform investors of the risks and benefits associated with stop orders, particularly in volatile markets.
In bitcoin trading, where prices can vary by thousands of dollars in a single day, the incorrect use of stop orders can lead to enormous amounts of unrealized gains, or far greater losses than if a stop-limit order were used. The same is true in reverse.
For firms that allow investors to create and manage their own stop orders online, FINRA recommends that they provide “clear and comprehensive disclosures to customers” at the time of creating the order, as well as “implementing systemic safeguards around the use of stop orders.”
Transparency and open communication regarding market conditions
FINRA further recommends that brokers and financial advisers provide clear and open information to investors regarding market conditions before customers set up stop orders. Firms must also provide clear information on any current market abnormalities or volatility.
On a systemic level, FINRA suggests implementing clear warnings before customers confirm the entry of their stop orders. This can be done through the use of pop-ups that provide clear information which the customer must confirm that they have read and understood before committing.
Lacking a thorough understanding of stop orders and stop-limit orders, investors might believe that their investments are safe and their risks are reduced. This is not always true.
It is the responsibility of the financial firm the investor is dealing with to ensure the investor is fully educated regarding the risks and benefits of utilizing this tool.