How a Stop Loss Works? A Clear Explanation

A stop-loss order is an instruction to automatically close a position if the price reaches a specified level, intended to limit further losses on that trade. A trader sets this level, generally at the time a position is opened (though it can typically be adjusted afterward), based on the maximum loss they're willing to accept on that specific trade.

A standard stop-loss order triggers when price reaches the specified level, but it's then executed at the next available market price, which is not always identical to the specified trigger level. In most typical market conditions, this difference is minimal, but during periods of high volatility or low liquidity — concepts covered in the Market Guides module — the executed price can differ meaningfully from the level originally specified.

As covered in the Understanding Volatility unit, price gaps occur when price moves from one level to another without trading at the levels in between, often due to significant news occurring while a market is closed or during periods of extreme volatility. If price gaps past a stop-loss level, the order will generally execute at the next available price after the gap, which could be notably worse than the originally specified stop level — this is directly connected to the slippage concept covered in the Trading Essentials module.