Stop/Stop-Limit orders can be helpful for enforcing a max loss strategy, especially if you can’t be in front of a trading screen during all the hours the market is open. A standing order, decided in advance, can also take some of the emotion out of trading and act faster (possibly reducing losses) than you would be able to do manually.
Stop orders are based on some aspect of price and the choices can vary broker to broker but Mark and Bid may be common choices.
Unfortunately, during times of high market volatility (such as around Fed announcements, other major news, last trading day of the month, etc.), the Bid, Ask and Mark can temporarily go to extremes causing your stop to be hit. Often the extreme prices may last only a few seconds, but it is still long enough to trigger your stop, when it would not have been otherwise triggered.
Depending on the situation, this may cause losses or just be inconvenient. You can try to re-enter the position, but you may not get in at favorable prices. And at the least you will have two extra sets of unnecessary commissions.
What I learned this week is when this happens; you can call your broker’s trade desk and request that the trade be “busted” (i.e. cancelled). There are several things to know. First, this is a request, not a guarantee. The desk will verify that the problem is some temporary insanity in the market and not a mistake on your park. If the trader on the desk agrees, they will need to call their back office who, in turn, will contact the market maker to see if something can be done. Second, the sooner you make the request, the better. Ideally, you want to make the request the same day and before the market closes. The longer you wait to request the bust, the lower your chances. If you wait more than a day, your chances may be nil.
An alternative to using stop orders is to use alerts. You can have alerts go to your computer and/or your cell phone. This is viable. Problems with alerts, even to a cell phone, is that there can be occasions where you are away from the phone, be out of a cell tower range, have it turned off or have the sound turned down and miss the alert.
Stop limit orders vs. stop orders have pros and cons. A stop order will become a market order when triggered. If the extreme market conditions are still in effect, you could get a very bad fill. But at least you are out of the trade. A stop limit order with a limit price placed (say 15 cents away) from the stop price will at least insure that your fill price is not too bad. But if the market has moved past your limit price you may not get filled at all, so there is risk there.
The above experience came from doing credit spreads on indexes.
It would be interesting to hear of other trader’s experience with using stop/stop-limit orders.
Thanks for this post, most practical. I don't use stop orders for reasons you mentioned above. My way of dealing with the problem in the past was to monitor market frequently when expecting moves that could be dangerous to my positions. I was aware of risk doing it this way and usually didn't allow to put myself into position to be hit by devastating losses. If remember correctly, I was using Stop orders long time ago when trailing positions, it was without knowledge you presented above.
I'm surprised that filled orders can be 'busted' the way you described.