- Brokers don't charge for setting up stop-loss orders (although some still charge commissions on the actual trades), making them essentially a no-cost insurance policy to limit losses on investments.
- Routine use of stop-loss orders helps investors become more disciplined about selling losing stocks.
Disadvantages of the stop-loss order
There are disadvantages to using stop-loss orders. First, establishing a stop-loss order doesn't limit an investor's loss to the difference between the purchase price and the pre-determined sale price. If a company reports disappointing earnings after the market closes, for example, then its share price by the start of the next trading day could be well below an investor's stop-loss price.
Another potential pitfall of stop-loss orders is that they can trigger a stock sale even if the stock's price dips only slightly below the trigger price before quickly recovering. If a stock's price is volatile or another event occurs that causes a brief sell-off by other investors, that can trigger an investor's stop-loss order.
Finally, during sharp market declines, sophisticated investors like hedge fund operators sometimes try to take advantage of the existence of stop-loss orders. Known as "stop hunting," traders short stocks already in decline in order to push prices lower in an attempt to trigger a flood of stop-loss orders. These investors subsequently start buying those same stocks to profit from an expected rebound.
