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Stop Loss Orders

Placing a stop-loss order is a tactic whose name says it all, and best of all, it's easy to set up. You create an order with a stop price that's lower than the current market price on the stock or ETF. If the stock's price drops enough to hit your designated stop price, the order becomes a market order and is executed at the best price available. You can use a stop loss order to put a floor under your potential loss on a security if the investment's price drops below a certain value.

If the price continues to fall after your order goes through, you've protected yourself from an even bigger hit. Ideally, you'll have recovered your purchase price and protected some gain, or at least minimized your losses. What's more, if you think the investment is still one you'd like to own, you can always repurchase it at the new lower price. If you do that, keep an eye out for a wash sale - this action may trigger a deferred tax loss. Talk to your tax advisor to understand how this could affect you.

The challenge is choosing the right stop price. You want it to be high enough to achieve your goal of limiting losses but low enough so that it's not triggered by a short-lived market dip.

What's the risk?

The risk with a stop-loss order is that you could sell for less than the stop price if the price drops quickly and your order is executed at a lower price than you would have preferred. For example, if you created a stop-loss order to sell at $29 a share, that order would become a market order when the market price hits $29, triggering your sale. If a lot of investors are selling at the same time, maybe because some bad news about the company had just been announced, the price might be $28.50 when your sale is complete. Or it might be $27, or even less.