Definition, Examples, When to Use It
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- A stop-limit order is an advanced investment tool used by stock traders to maximize gains and minimize losses.
- They combine the features of stop and limit orders.
- You can buy or sell using a stop-limit order and set the parameters for the execution of the order according to your conditions.
Stop-limit orders are a way for investors to control their trades while managing the level of risk. A stop-limit order has two aspects: the stop price and the limit price. The stop price indicates that you will buy or sell at a specific price. The limit price sets the criteria for buying or selling a certain amount of stock when the price reaches the set price.
Below is information about this conditional transaction type and how it is used.
What is a stop-limit order?
A stop-limit order is a financial tool that investors can use to maximize gains and minimize losses. Securities and Exchange Commission (SEC) A stop-limit order is described as combining separate stop and limit orders into a single instrument that investors can use as part of their risk mitigation strategy.
A stop-loss order, sometimes called a stop-loss order, is when you place a specific stop-loss price on a stock. Once this stop price is reached, the order to buy or sell the stock is executed. The order then becomes a market order – immediately actively traded on the market.
A limit order is an order to buy or sell a stock at a specific price. So, if you want to buy a stock at $20, you can place a limit order for that amount, and the order will only be executed if the stock price is $20 or higher.
A stop-limit order combines the two advantages of a stop-loss order and a limit order into one financial instrument. Stop orders set the price at which the order will be executed, and limit orders specify how much to buy or sell at that set price.
A single stop loss order instantly becomes a market order trade, while a limit order becomes a limit order that can only be executed at the set price or even better.
“Stop-limit orders are orders to buy or sell a stock when the market reaches a specified price, but once the stock is bought or sold, the order becomes a limit order price below the trigger amount,” explains Jenna Lofton said she is a former certified financial advisor with an MBA in finance, and Stock beater. “This type of order has one last chance to fill before it gets cancelled without any execution. It helps prevent washouts and sudden spikes — especially on highly volatile stocks.”
Learn how stop-limit orders work
The stop-limit order combines the features of stop-loss and limit orders, creating a powerful strategy for investors to control costs. Investors need to set two price points:
- stop price
- limit price
The stop and limit prices do not have to be the same. The stop price you set triggers the execution of the order and is based on the price at which the stock was last traded. The limit price you set is the limit price that sets the price limit for trading and must be executed at that price or better.
“While trading, you can watch the market price and decide to buy or sell at any given moment, or you can adjust the process so that it only activates when the price reaches or exceeds price point A (stop loss) but does not break out Pass price point B (limit). The latter option is called a stop-limit order,” explains Adam Garcia, TheStockDork.com“So once a stock starts going higher, you basically want to buy. On the other hand, there’s only so much you can afford, which is why you need to limit it.”
Let’s say your stop-limit order has a stop price of $50 and your limit price is $45. If market conditions are right and the stock price reaches $50, it will trigger a limit order, which can only be activated at a limit price of $45 or higher.
Investors can execute stop-limit orders on their trades through their investment brokerage firm, but not all brokerage firms offer this option. Also, brokers may have different definitions for determining whether a stop or limit price has been reached.
The trader sets the time period for which the stop-limit order is valid, or can choose the Good Until Cancellation (GTC) option. With these options, a stop-limit order remains in effect until the trigger price to buy or until the trade expires. Stop-limit orders are executed during market hours.
You set the stop loss price that triggers the execution of the order. A limit price helps reduce risk by stating that an order must be below or above the limit price.
“You need to specify a time frame to execute this trade. But given that this trade is conditional, there is no guarantee that it will actually happen. To make matters worse, this time frame only includes regular trading hours. If part of your order is executed today , the rest will be distributed over a few days, and your broker may charge several commissions, not just one,” warns Garcia.
The pros and cons of stop-limit orders
Consider the pros and cons before deciding if a stop-limit order is right for you.
Using stop-limit orders in your investment strategy is a way to gain more control over how you invest and how much you invest. You can set buy and sell limits and set the parameters for executing orders according to your conditions.
While this strategy has its benefits, you should be aware that price swings throughout the day may trigger orders that are “significantly lower” than the closing price of the stock that day, according to Investor website.
Be sure to check if your brokerage offers this option and how they define prices so you know when your order will be executed.