What is the purpose of a stop loss order?

What is the purpose of a stop loss order?

• A. To buy securities when prices rise
• B. To sell a security when its price drops to a certain level
• C. To ensure a security remains in your portfolio
• D. To cancel pending buy orders automatically

Answer: (B)

A stop loss order is designed to limit an investor's loss on a position in a security. By placing a stop loss order, the investor specifies a price at which a security will be sold if its market price falls to that level. This mechanism helps in managing risk by ensuring that losses do not exceed a predetermined amount, allowing investors to exit positions automatically without having to constantly monitor the market.

In contrast, other options do not reflect the function of a stop loss order. For example, buying securities when prices rise is more aligned with a buying strategy rather than a protective measure like a stop loss. Ensuring that a security remains in your portfolio contradicts the intent of minimizing losses since a stop loss order is about selling at a lower price to avoid further declines. Lastly, canceling pending buy orders automatically does not relate to the concept of a stop loss; rather, that pertains to order management without the goal of loss mitigation. Thus, the primary function of a stop loss is indeed to sell a security when its price drops to a specific level.