What is the purpose of a stop order in trading?

The purpose of a stop order in trading is to trigger a transaction when a security reaches a specific price. This type of order is designed to protect an investor from significant losses or to lock in profits. When the market price of the security reaches the predetermined stop price, the stop order becomes a market order and is executed at the next available price. This mechanism is particularly useful in volatile markets, allowing traders to establish buy or sell positions based on their strategy and risk management.

For example, if an investor owns a stock currently trading at $50 and wants to limit their loss, they might place a stop order to sell at $45. If the stock drops to $45, the stop order triggers and sells the stock at the best available price, helping to manage risk.

In contrast, the other options do not accurately describe the function of a stop order. A stop order is not about selling at a fixed price, restricting trading during market hours, or collecting dividends, all of which pertain to different trading concepts. The specificity of the stop order mechanics is essential for understanding the strategic role it plays in trading decision-making.