Everything You Need To Know About Stop-Limit Order

May 3, 2023
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Stop-limit orders give traders more agency by setting individual limits on the highest and lowest possible prices. Limit orders direct the market maker to purchase or sell stock at the specified price if and only if the stock price reaches the stop price. The investor's willingness to take a loss is a key factor in setting a loss limit. Stop-limit orders are submitted by traders and recorded in the order book of a public exchange. The order will stay in effect until it is either executed, canceled, or terminated. When placing a stop-limit order, investors must provide the time frame during which the order will be in effect for the present market or for future markets.

What is a Stop-Limit Order?

A stop-limit order is a measure that may be used by traders to restrict their exposure to loss by setting a maximum or minimum price for a stock. Stop-limit orders combine the risk-reducing aspects of a stop order with the more aggressive ones of a limit order in a conditional transaction that lasts for a certain period of time. It is connected to stop-on-quote orders and limit orders. A stop order is an order that allows for either the purchase or sale of stocks after their value has exceeded a given point. A limit order is an order that allows for the purchase or sale of a specific number of shares at a certain or better price.

Explanation of how a Stop-Limit Order works

A stop-limit order's main benefit is that it gives the trader granular control over the order's fill time. The risk, as with all limit orders, is that the deal may not be completed if the stock or commodity in question does not reach the stop price within the allotted time frame.

Setting the stop price and the limit price for a stop-limit order very essential. You should initiate a trade by first setting a stop price level. When the stock's price hits or drops below the stop price, the transaction is executed. Once they are in place, you may settle on a limit value/price. The limit price is the maximum purchase or sale price you are willing to accept for the security. This is the upper or lower bound on the price you're willing to pay or get in the deal. The stop-limit order may only be executed within the specified time window.

Once a predetermined stop price is reached, the stop-limit order will be executed at the next available better price. Stop-limit orders automatically convert to limit orders to purchase or sell at the specified limit price or better whenever the stop price is met. Almost every online broker opts for this kind of order.

An important thing to keep in mind about stop-limit orders is that they do not ensure that your transaction will be completed. The order may not be honored at the requested limit price or at all if the security's price suddenly declines or there is a market gap during the trade. In the event that the required prices aren't reached, this may lead to the acquisition of losses.

Characteristics of Limit and Stop Order

When a certain price is achieved, a stop order becomes feasible and is filled at the trending economic value. No matter what happens to the price of the underlying asset while the stop order transactions are executed, a typical stop order will always be filled in full.

Limit orders are those that are placed at a predetermined price. When the deal can be completed at the limit price or at a price deemed more beneficial than the limit price, the order will be executed. If the market price moves away from the limit price as a result of trading activity, the order will be cancelled. The investor's ability to execute the deal with pinpoint accuracy is greatly enhanced by merging the two orders.

If the market price falls after the stop price is reached, the order will be completed at the market price. Because of this, transactions may be finalized at less-than-ideal pricing if the market suddenly shifts. By merging the stop order with the attributes of a limit order, an investor may prevent the order from being filled if the market price falls below a specific set threshold. So after the stop price is reached in a stop-limit order, the limit order kicks in to prevent the order from being executed until the price reaches or exceeds the limit price or threshold value set by the investor.

Although placing a stop-limit order doesn't cost anything, it's important to familiarize yourself with your broker's fee system to avoid any unpleasant situations.

The Pros and Cons of Stop-Limit Orders

Advantages of Stop-Limit Orders

Traders may depend significantly on stop-limit orders for a number of reasons, including the order's numerous notable advantages. They include:

  • Stop-limit orders are useful for risk management because of how well they restrict risks and losses. If the market does not favor an investor, they may limit their losses by establishing a stop price. Setting a limit price protects you from being filled at an unfavorable price which may be too high or very low. This helps investors limit their exposure to risk and protect their capital.
  • Stop-limit orders are automatically completed when the specified stop price is reached after they have been placed. You may let the order execute without having to keep an eye on the market all the time. This may be particularly helpful for traders who either don't have time to keep track of the market or want a hands-off approach type of transaction.
  • Stop-limit orders allow you to set the price at which you join and leave a transaction. This implies that, while buying or selling, you might specify a limit price that is more than the stop price. This allows investors more say over the execution price and protects traders from being filled at a disadvantageous price. Thus, an investor is allowed to have control over the price.
  • Stop-limit orders are versatile and may be incorporated into several trading styles, such as swing trading, position trading and day trading. Both long and short positions may utilize to join or leave the market. Stop-limit orders are useful for traders due to their flexible nature, and hence they may be tailored to the investor's preferred trading strategy and technique.

Stop-Limit Orders' Drawbacks

While Stop-limit orders are suitable because of their many benefits, there are also flaws which include:

  • Stop-limit orders have an extremely complex nature. This makes it difficult to put up and carry out, even in comparison to other forms of orders. Setting a stop order requires more inputs, considerations, and factors than placing a market order or a limit order. The ability to establish a stop price and a limit price, as well as an understanding of their effects on the market, are essential skills for every investor.
  • Traders' emotions may be strained by the psychological pressure that stop-limit orders might generate. It's human nature to want to hang on to a losing position after a stop-loss is triggered in the vain expectation that the market will eventually turn and the price will rise again. Because of this, traders may get paralyzed by doubt and act irrationally, both of which are bad for their portfolios.
  • Stop-limit orders also have the potential drawback of not safeguarding you from price gaps. A price gap arises when the value of a security suddenly increases or decreases with no intervening trading activity. If this occurs and your maximum price is not reached, you may be forced to accept a considerably worse price when your order is completed.
  • Uncertainty: Even though a stop-limit order allows you to specify the price at which you want to join or leave a transaction, there is no assurance that it will be filled at that specific price. Your order could not be filled at all if the market fluctuates rapidly and the price never reaches your limit value. This may be particularly troublesome in dynamic marketplaces where prices often change. Hence this may lead to uncertainty.

Choosing Between a Stop-Limit Order and Stop-Loss Order

Traders who want to minimize losses risks might benefit from using both stop-limit orders and stop-loss orders. There are important distinctions between the two that alter the contexts in which one may be optimal. When the security's price reaches or falls below the stop price, the stop-loss order automatically converts into a market order. This implies that the stop price and the market price may be different from one another when the order is executed. When the stop price is reached, a stop-limit order automatically converts to a limit order and will only be executed at the limit price or better. This means that the timing for each is distinct.

Also, several levels of price safety are available. The stop price is the only level of protection provided by a stop-loss order. Therefore, the transaction might be completed at a price lower than the stop price if the market is experiencing dynamic price changes or gaps. Stop-limit orders, alternatively, provide price protection by allowing the trader to choose the maximum price at which they will purchase or sell. A trader may have more influence on the final price at which a deal is executed as a result.

It is also assured that a stop-loss order will be executed if the stop price is reached. However, the execution price itself is not guaranteed. A stop-limit order, on the other hand, will only be executed if the limit price is reached. If a trader wants to guarantee a transaction will be completed at whatever price, a stop-loss order is an alternative to take.

The distinction between Stop-Limit Order and the Stop-Loss Order

Stop-limit orders guarantee execution at the specified price, while stop-loss orders guarantee execution at the specified loss. There are a few factors to consider while deciding on an order format.

When the stop-loss limit is reached, the order to sell is executed at the current market price. When the price of an asset an investor is long on suddenly drops rapidly, the stop-loss order may be executed at a price far lower than the original stop-loss level. This may be a huge concern for long positions when stock gaps are down, as could happen following an earnings release, and for short positions when stock gaps are up.

An order that combines a stop-loss and a limit is called a stop-limit order. By setting a limit price, the investor guarantees that the stop-limit order will only be executed at or above the set price. It is possible that the order will not be filled at all, as is the case with every limit order, putting the investor in a losing position.

Can You Use Stop-Limit Orders After Market Hours?

Only during regular market hours (usually 9:30 a.m. to 4 p.m. EST) can stop-loss orders be executed. They will not be carried out during regular market hours or on weekends and holidays when the market is closed.

What is the time frame of a stop-limit order?

Stop-limit orders may be entered as day orders, which will expire at the close of the current market session, or as good till canceled (GTC) orders, which will remain in effect for subsequent trading sessions until cancelled. You should verify the length of time your GTC order will remain in effect since this varies among trading platforms and brokerages.

Conclusion

Investors and traders employ stop-limit orders, a type of conditional order, to restrict their exposure to potential risks. The order merges a stop and limit order attribute, giving the trader greater control over the completion market price, allowing them to better protect their capital. An investor places a stop order at the price at which they want the order to activate and a limit order at the price at which they want the transaction to be executed. An investor's limit order will activate and be filled if and only if the security's price hits the investor-specified trigger price. Stop-limit orders for the day or good till cancelled are available from most online brokers.