What is the primary function of a stop loss order?

What is the primary function of a stop loss order?

• A. To gain maximum profit on a stock
• B. To limit potential losses on a stock position
• C. To initiate a purchase at a certain price
• D. To speculate on market trends

Answer: (B)

The primary function of a stop loss order is to limit potential losses on a stock position. This type of order is designed to automatically sell a security when its price falls to a predetermined level, thus helping investors manage risk. By setting a stop loss, investors can protect themselves from significant losses during market downturns or unexpected price movements.

Using a stop loss order encourages disciplined trading and can be a vital part of a risk management strategy, as it takes the emotion out of the decision-making process in volatile situations. While it might not maximize profits, its key role is to safeguard investments and prevent losses from escalating beyond a comfortable threshold, ensuring that traders can remain active in the market without exposure to excessive risk.