Increasing Your Profits with a Soft Stop

A soft stop is a theoretical position or price where a trader will execute a trade. The position is "soft" because it is subject to change if market conditions change. A soft stop can be thought of as a guideline but not a hard rule. Traders can elect to ignore a soft stop or enforce it at any point in the future, while they do not have this leeway with an actual "stop order." Using soft stops can make a portfolio more flexible to the market.  

Stop Order

A hard stop, called a "stop order," is a specific directive to buy or sell a security once it reaches a set price point. Stop orders are very useful to both maximize profit and prevent losses. For example, if you know you purchased a security at $7 a share and believe it will not climb any higher than $10 per share, you may place a stop order at $10. When the security reaches this point, your broker will automatically sell it, providing you with the profit, and preventing the chance you will lose profits when the price turns down again. On the reverse side, you can place a stop order if your security falls below $5. In this case, the most you can ever lose will be $2 per share, protecting you from a sharp crash in the market. 

Stop Order vs. Soft Stop

While a stop order is an extremely useful tool to protect your earnings, it is also highly rigid. Your broker or trader has very little flexibility to read the market. In the above example, your broker may feel the security will rise to $11 given current market conditions. With your stop order in place, though, he or she will have to sell. Using a soft stop instead, the broker will become very wary once the security hits $10. But, he or she will be able to hold out if it appears the market will continue to push the price up. Market momentum can be used to make better decisions at the exact time the stop comes into effect. 

When to Use Soft Stops

Investors who like to exercise a large degree of control over their investments may prefer to stick to stop orders. However, those investors who trust their brokers to make some decisions for them may consider a soft stop instead. The broker will alert the investor when the price approaches the soft stop point, but the broker can also provide advice on whether or not to execute the trade. In a standard market, this can be extremely beneficial. In an extremely volatile market, though, losses may occur very quickly, prior to the time the broker can properly advise a client. Stop orders with immediately guarantees of execution may be wisest in a volatile market or on highly risky investments. At that point, protecting against large losses and making moderate returns will become the focus of most investors. Turning large profits can wait until the market stabilizes. 

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