Protective Stop
A protective stop is a stop-loss order deployed to guard against losses, usually on profitable positions, beyond a specific price threshold. A protective stop is a stop-loss order deployed to guard against losses, usually on profitable positions, beyond a specific price threshold. This strategy offers trading discipline to investors by helping them make important decisions about cutting losses, but it can also, at times, mitigate profitable opportunities. A protective stop is a popular strategy for risk-averse investors who can use tools, such as downside deviation and semivariance, to measure a security's risk threshold. A protective stop is a strategy designed to protect existing gains or thwart further losses by means of a stop-loss order or limit order. A protective stop is a stop-loss order deployed to guard against losses, usually on profitable positions, beyond a specific price threshold. A protective stop is a stop-loss order deployed to guard against losses, usually on profitable positions, beyond a specific price threshold. This strategy offers trading discipline to investors by helping them make important decisions about cutting losses, but it can also, at times, mitigate profitable opportunities. A protective stop is a popular strategy for risk-averse investors who can use tools, such as downside deviation and semivariance, to measure a security's risk threshold. A protective stop is a strategy designed to protect existing gains or thwart further losses by means of a stop-loss order or limit order. A protective stop offers trading discipline to investors by helping them make important decisions about cutting losses, but it can also, at times, mitigate profitable opportunities. A protective stop is set to activate at a certain price level and normally guarantees that an investor will make a predetermined profit or limit their losses by a predetermined amount. A protective stop is a popular strategy for risk-averse investors.
What Is a Protective Stop?
A protective stop is a stop-loss order deployed to guard against losses, usually on profitable positions, beyond a specific price threshold.
Understanding Protective Stop
A protective stop is a strategy designed to protect existing gains or thwart further losses by means of a stop-loss order or limit order. A protective stop is set to activate at a certain price level and normally guarantees that an investor will make a predetermined profit or limit their losses by a predetermined amount. For example, if you buy a stock for $50 and want to limit losses to 10%, or $5, you would simply set a protective stop at $45.
A protective stop offers trading discipline to investors by helping them make important decisions about cutting losses, but it can also, at times, mitigate profitable opportunities. In other words, it can act as both a risk-averse strategy and a profit-averse nightmare. Because it assumes that a security will continue to fall past the exit target, a protective stop can sometimes backfire with volatile securities that have a wide trading range. Hence, it is prudent to consider the behavior of the security when using or setting a protective stop. Because the "stop" acts as a floor, any subsequent rebound in that security after hitting the protective stop guarantees that the investor will be "stopped out" prior to the advance.
It is prudent to consider the behavior of the security when using or setting a protective stop.
A protective stop is a popular strategy for risk-averse investors. Often, their tolerance for losses is far lower than other defined investor personalities. Popular tools for measuring risk include downside deviation and semivariance. Both measures are effective risk management techniques that can be added to a position and automatically triggered, often without a financial advisor's intervention.
A common rule of thumb from behavioral finance says that investors experience the pain of loss two to three times as much as the joys of a gain. This phenomenon has come to be called prospect theory. As financial advisors increasingly add psychological factors to asset management, techniques like the protective stop may grow in popularity.
Related terms:
Asset Management
Asset management is the practice of increasing wealth over time by acquiring, maintaining, and trading investments that can grow in value. read more
Cutoff Point
A cutoff point is a point at which an investor decides whether or not to buy a security. An investor's risk aversion can impact their cutoff point. read more
Downside Deviation Defined
Downside deviation is a measure of downside risk that focuses on returns that fall below a minimum threshold or minimum acceptable return (MAR). read more
Downside Protection
Downside protection refers to the techniques an investor or fund manager uses to prevent a decrease in the value of the investment. read more
Hard Stop
A hard stop is a price level that, if reached, will trigger an order to sell an underlying security. read more
Limit Order
A limit order is used to buy or sell a security at a pre-determined price and will not execute unless the security's price meets those qualifications. read more
What Is an Order?
An order is an investor's instructions to a broker or brokerage firm to purchase or sell a security. There are many different order types. read more
Profit Target
A profit target is a predetermined point at which an investor will exit a trade in a profitable position. read more
Prospect Theory
Prospect theory argues that if given the option, people prefer more certain gains rather than the prospect of larger gains with more risk. read more
Risk Averse
The term risk-averse describes the investor who prioritizes the preservation of capital over the potential for a high return. read more