What is Hard Stop?
When the market price drops to a certain level, investors use a risk management tool called a hard stop, or a stop order, or a stop-loss order, to sell their securities units. Its purpose is to minimize losses during market fluctuations and unexpected events. However, using a hard stop may result in missed gains if the security's price recovers after the stop is executed. The hard stop remains in effect until the order is filled or canceled.
Hard Stop Explained
A hard stop serves as a proactive measure against potential market downturns and remains in effect until the underlying security price reaches the designated stop level. Notably inflexible in nature, a hard stop differs from a mental stop, where a trader might hold a specific price in mind but delays taking action until the stop price is actually traded. At this moment, adherence to the predetermined selling rule becomes an optional choice for the trader.
The conversion of a mental stop to a hard stop is achieved by placing a standing order in the system under a "good-till-canceled" status. This approach eliminates the necessity for strict discipline in executing an exit order. While this form of order does not fully defend against sudden price gaps, it does offer the advantage of ensuring an exit at the earliest feasible price once trading resumes, subsequent to a gap below the initial stop price level.
In the pursuit of optimizing their trading strategies, many traders opt to implement a hard stop once their investments generate profits, maintaining the order's active status until it hits the pre-determined price target. For instance, a technical trader might procure a stock following an escape from an ascending triangle pattern and position a hard stop marginally below the upper trendline support. This strategic approach entails plans to either capitalize on the price target achievement or exit the position in the event of a failed breakout, thereby demonstrating the cautious and calculated decision-making prevalent in trading