A stop-limit order is one of many options available to traders when placing trades.
Stop-limit orders allow investors more control over the price that their stock is being bought or sold at.
Stop-limits are an important part of any investor’s trading strategy, and understanding how they are used can help reduce losses and/or lock in profits.
In essence, a stop-limit order combines elements of a “stop loss” order and a “limit” order.
A stop loss order is simply an order that is put in place to be executed when a stock goes below a specific price.
On the other hand, a limit order can be placed on either the buying or selling side of a trade.
For limit buy orders, execution happens after a stock falls under a specific price.
For limit sell orders, execution happens after the stock rises above a specific price.
While the three most common order types are market, stop, and limit orders, there are actually over 40 order types that can be used to execute a wide range of advanced trading strategies.
Aspects of these two are combined to create the stop limit order.
Stop limits can be set up on either the buy- or the sell-side of a trade.
For sell stop limits, once the stop price is reached, the order will then convert into a regular limit order.
This order will then be executed at the specific limit price (or better).
For buy stops limits, traders set a stop price and then a limit price at the highest price they are willing to pay for a stock.
How Does a Stop Limit Order Work?
A stop limit order can be illustrated using two simple examples Firstly, let’s imagine a trader who owns shares of Apple at $150 per share.
As the trader does not check his portfolio every day, he wants to make sure that he has a stop-limit in place so that he can sell his shares if prices suddenly dip.
So he sets a stop price at $145 and a limit price at $140.
In this situation, once the stock falls to $145, a limit order is activated.
This will sell his shares as long as the price stays above $140.
For a buy stop-limit order, let’s imagine a trader wants to invest in Apple at $160 a share.
The share price is currently $150, so he sets a stop-limit order with a stop price at $155 and a limit price at $160.
Once the price hits $155, the order will be activated and filled as long as the price stays below $160.
As these examples show, stop-limit orders can help both buyers and sellers ensure they are able to secure favourable prices for their trades.
Advantages of Stop Limit Orders
1. Less time checking portfolio
With a stop limit in place, investors can relax and not worry about having to check their portfolio every day.
Even if they miss big price movements, having stop limit orders in place ensures that trades will be executed as long as they are within the parameters they set.
2. Precise Orders
With alternatives like market orders, traders may not be getting the best price on their trades.
Stop-limit orders allow for a much more limited range of prices, so traders know exactly what they would be paying before the trade even executes.
Disadvantages of Stop Limit Orders
1. Orders may not execute in time
While having the peace of mind from stop-limit orders is nice, they are not always the best insurance policy.
Especially in the case of extreme volatility, stop-limit orders may pass through your price range before your broker has a chance to execute the trade.
This risk is particularly high on low-volume stocks.
2. Orders may only partially fill
In cases where prices are fluctuating, orders may not completely fill.
This means that you may only be able to sell a portion of your stock before the price rises or drops out of range.
Frequently Asked Questions
- When should I use a stop limit order?
Stop limit orders are great for investors who do not want to check their portfolios every day. Setting a stop-limit order provides assurance that your trade will execute without any action required.
- What’s the difference between a limit and a stop-limit?
These two popular methods for executing trades have many similarities. The main difference is that a stop-limit provides a “condition” before a trade is executed (i.e. price must fall or rise below a certain price before the limit order is executed. Having the “stop” price in place for a stop-limit order allows for more control over exactly when the sale/purchase happens and can be used to take advantage of swings in price movements.