What is the primary purpose of a stop-loss order?

The primary purpose of a stop-loss order is to limit potential losses by selling a security when it reaches a specific price. This type of order is an essential risk management tool for investors, aiming to protect their investment value. By setting a predetermined price at which the security will be sold, investors can avoid excessive losses in a declining market, thus providing a safeguard against significant downturns.

For instance, if an investor owns a stock currently priced at $50 but sets a stop-loss order at $45, the stock would be automatically sold once its price drops to or below $45. This cap on potential losses allows investors to manage their risk more effectively, ensuring they do not hold onto an asset that continues to depreciate. The stop-loss order helps to create a disciplined approach to investing by encouraging exits from positions that are not performing as expected.