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Wouldn’t it be nice if you could set specific price points for trades to maximize your investing profits? Stop-limit orders do exactly that.
Traders willing to invest a little bit of time and effort setting the “stop” that starts the trade’s target price and the “limit” that is outside of the trade’s price target have the potential to make significantly more money on trades. Additionally, stop-limit orders are utilized by investors to mitigate risk and to protect themselves from catastrophic losses.
Without further ado, let’s delve into the details of stop-limit orders.
What Is a Stop-Limit Order?
A Stop-Limit Order is best described as a conditional trade established across a specific time window, combining “stop” and “limit order” features.
The goal of a stop-limit order is to minimize risk. Limit orders are orders to buy/sell a certain number of shares at a specific price point or higher. In the trading and investing world, this is known as “locking in profits.”
Stop-on-quote orders are orders to buy/sell a stock or other security after the price has moved beyond a specific price point.
Stop-limit orders combine these two types of trades, serving as a conditional trade that reduces risk and creates the potential to lock in gains. Stop-limit orders give investors complete control over entry/exit points. However, there is no guarantee the stop-limit order will be executed.
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How Do Stop-Limit Orders Work?
Stop-limit orders require investors to set two specific price points. The stop is set to specify the desired price. The limit is outside of the trade’s target price.
The stop-limit order will no longer prove executable if it is not triggered within the designated timeframe. If the stock moves to the specified price or a better price, it is executed.
The stop-limit order transitions to a limit order when the stop price is hit. This is how stop-limit orders work in plain English.
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Stop-Limit Order Example
Stop-limit orders are ideal when traders cannot actively monitor the market. This type of order activates a buy or sell order on the trader’s behalf, so they are liberated to focus on other matters, be it a 9 to 5 job, family responsibilities, or another trade.
The order is automatically triggered as soon as the designated price is reached. A buy stop limit can be used to purchase a stock if it hits a specific price. The trader specifies the stop and limit prices after pinpointing the highest price they are willing to pay.
The stop price is the price above the stock’s market price. The limit price is the highest possible price the trader will pay.
For example, if XYZ company is trading at $60 yet the stock will likely rise soon, a stop price can be established at $65.
This means when XYZ company’s stock price hits $65, the trade is automatically executed. If the cap is set at $70, the order will be processed when the stock hits $65. It will not be filled if the stock moves over $70.
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Why Would You Use a Stop Limit Order?
The logic in using a stop-limit order ensures that trades are executed at specific price points when a trader is not monitoring market dynamics. This automated order triggers the purchase or sale of a security at a specific price point. Ultimately, stop limit orders allow investors to mitigate risk and capitalize on upward momentum.
Pros and Cons of Stop Limit Orders
- Allows traders to automate their investing strategy
- Enhances investor control over transactions
- Puts a cap on the amount of money invested in a specific trade or security
- Traders control the amount of time the order remains open
- The order might not be fulfilled if the stock does not reach the target number
- A partial fill could occur in which only a percentage of the orders’ shares are executed, ultimately causing part of the order to remain open, leading to that many more commissions.
Stop-Loss vs. Stop-Limit Orders: How Are They Different?
Stop-loss and stop-limit orders are phonetically similar, but they are not the same. Stop-loss orders are those in which shares are sold with a stop price to start the order.
Stop-limit orders are different in that there is a limit price. Stop-loss orders have no such limit price, so a market order is used. When in doubt, lean on your broker or another financial advisor for guidance on whether it is better to use a stop-loss order or a stop-limit order.
Bottom Line: What Is a Stop-Limit Order?
This unique type of order is essentially a conditional trade in which the components of limit and stop orders are used in unison.
Stop-limit orders successfully minimize risk, give traders additional control over the timing of order fills, and lock in profits.