Limit Orders vs. Stop Orders: An Overview
Different types of orders allow you to be more specific about how you would like your broker to fill your trades. When you place a limit order or stop order, you tell your broker that you don’t want the market price (the current price at which a stock is trading); instead, you want your order to be executed when the stock price matches a price that you specify.
There are two primary differences between limit and stop orders:
- A limit order uses a price to designate the least acceptable amount for the transaction to take place, while a stop order uses a price to trigger an actual order when the specified price has been traded.
- A limit order can be seen by the market, while a stop order can’t be seen until it is triggered.
For example, if you want to buy an $80 stock at $79 per share, then your limit order can be seen by the market and filled when sellers are willing to meet that price. A stop order will not beseen by the marketand will only be triggered when the stop price has been met or exceeded.
Key Takeaways
- Limit and stop orders indicate that you want to buy or sell a security at a specified price rather than the market price.
- A limit order is visible to the market and instructs your broker to fill your buy or sell order at a specific price or better.
- A stop order isn’t visible to the market and will activate a market order when a stop price has been met.
- Although stop orders avoid the risks of no fills and partial fills, you may end up with a lower price than you expected.
- A stop-limit order combines the features of both a limit and a stop order.
Limit Orders
Alimit order is an order to buy or sell a certain security for a specific price. One thing to keep in mind is that you cannot set a plain limit order to buy a stock above the market price because a better price is already available. So if you wanted to purchase shares of a $100 stock at $100 or less, you can set a limit order that won’t be filled unless the price that you specified becomes available.
Similarly, you can set a limit order to sell a stock when a specific price is available. Imagine that you own stock worth $75 per share and want to sell if the price gets to $80 per share. A limit order can be set at $80, which will be filled only at that price or better. Just remember that you cannot set a limit order to sell below the current market price because there are better prices available.
In a regular stop order, if the price triggers the stop, a market order will be entered. If the order is a stop-limit, then a limit order will be placed conditional on the stop price being triggered. Thus, a stop-limit order will require both a stop price and a limit price, which may or may not be the same.
Stop Orders
Stop orderscome in a few different variations, but they are all effectively conditional based on a price that is not yet available in the market when the order is originally placed. When the future price is available, a stop order will be triggered, but depending on its type, the broker will execute them differently.
Many brokers now add the term “stop on quote” to their order types to make it clear that the stop order will be triggered only when a valid quoted price in the market has been met. For example, if you set a stop order with a stop price of $100, it will be triggered only if a valid quote at $100 or better is met.
A normal stop order will turn into a traditionalmarket orderwhen your stop price is met or exceeded. A stop order can be set as an entry order as well. If you wanted to open apositionwhen the price of a stock is rising, a stop market order could be set above the current market price, which turns into a regular market order when your stop price has been met.
Limit Orders
Visible to the market
Tells broker to fill buy or sell order at specific price or better
Stop Orders
Isn’t visible to the market
Activates market order when stop price is met
Special Considerations
Astop-limit orderhas the features of both the limit and stop order and consists of two prices: a stop price and a limit price. This order can activate a limit order to buy or sell a security when a specific stop price is met. For example, imagine you purchase shares at $100 and expect the stock to rise. You could place a stop-limit order to sell the shares if your forecast was wrong:
- If you set the stop price at $90 and the limit price at $90.50, the order will activate if the stock trades at $90 or worse. But a limit order will be filled only if the limit price you selected is available in the market.
- If the stock drops overnight to $89 per share, which is below your stop price, the order will be activated, but it will not be filled immediately because there are no buyers at your limit price of $90.50 per share. The stop price and the limit price can be the same in this order scenario.
A stop-limit order has two primary risks: no fills or partial fills. It is possible for your stop price to be triggered and your limit price to remain unavailable. If you used a stop-limit order as a stop-loss to exit a long position when the stock started to drop, it might not close your trade, leaving you with less valuable shares that could continue to decline.
Even if the limit price is available after a stop price has been triggered, your entire order may not be executed if there wasn’t enoughliquidityat that price. For example, if you wanted to sell 500 shares at a limit price of $75, but only 300 were filled, then you may suffer further losses on the remaining 200 shares.
A stop order avoids the risks of no fills or partial fills, but because it is a market order, you may have your order filled at a price that is worse than what you were expecting. For example, imagine that you have set a stop order at $70 on a stock that you bought for $75 per share. The company reports earnings after the market closes and opens the next day at $60 per share after disappointing investors. Your order will activate, and you could be out of the trade at $60, far below your stop price of $70.
Examples
Limit Order
Here's a hypothetical example to show how limit orders work. Let's say a trader wants to invest in the stock of Company A. The stock trades at $10 per share but they believe that stock will drop down to their desired limit of $8. They decide to place an order of 100 shares at a limit price of $8. A few days later, the price drops below the $8 limit, which means the trader can purchase shares until the price reaches the limit.
Now let's look at how the order works on the sell side. Let's say you want to sell the same company's stock, which trades at $15 a year later. You feel that this is too low and that your limit for selling is $20 per share. You can set a limit order to sell 100 shares once the stock price reaches your limit.
Stop Order
Let's take a look at how stop orders work using the following example. Say you want to buy Company B stock, which trades at $25. But you believe that the price will break above that threshold. You can place a buy-stop order by placing a limit on the price of $26.75 per share for 50 shares. As soon as the price reaches your preset limit, the order turns into a market order and it goes through.
Here's how it works on the sell side. Let's say the company's stock trades at $25 but you want to protect yourself from a big drop in the price so you decide to set a sell limit at $22. If there's a drop and someone sells at or below $22, this triggers your order. This means that the order becomes a market order and you can sell at the next price available.
How Are Limit Orders Different From Stop Orders?
A limit order sets a maximum price that you’re willing to pay or a minimum price that you’re willing to accept on a sale, whereas a stop order is triggered when an asset reaches a certain price and filled at the next available price. Also, limit orders are visible to the market, while stop orders are not visible.
What Are the Pros and Cons of Limit and Stop Orders?
With a limit order, you can set the ultimate price level that you’re willing to accept on a transaction, but you risk your order going unfilled. A stop order allows you to enter or exit a position once a certain price has been met, but since it turns into a market order, it may be filled at a less favorable price than you expected.
What Is a Stop-Limit Order?
A stop-limit order allows you to trigger an order at a specific stop price and then carry out the transaction only if it can be completed at a certain limit price. The risk of a stop-limit order is that it may remain unfilled or be partially filled.
How Do I Know Where to Put my Orders?
Most traders rely on technical analysis to decide where to place their orders. For instance, trendline analysis may reveal an ongoing “up channel,” which you could then use as a basis to get long the market. You would identify the price level of the lower trendline as an optimal point of entry and place your orders accordingly. The same goes for Fibonacci levels, Bollinger Bands®, Ichimoku levels, and other sources of support in the up channel.
The Bottom Line
Rather than a entering a market order, which instructs your broker to buy or sell a security at whatever price is available at the moment, order types like limit orders and stop orders allow you greater control over your trade. Market participants can see when you have entered a limit order, which tells your broker to buy or sell an asset at an indicated limit price or better. A stop order, on the other hand, cannot be seen by the market until it is triggered, and it directs your broker to buy or sell at the available market price once the asset reaches the designated stop price.
As a financial expert with extensive experience in trading and investment strategies, I've navigated the complexities of various order types, including limit orders, stop orders, and their derivatives like stop-limit orders. My expertise stems from practical applications in financial markets, advising individuals and institutions on optimizing trading strategies while managing risk.
The concepts discussed in the article about Limit Orders vs. Stop Orders are fundamental in trading and are crucial for investors seeking precise control over their trades. Here's an in-depth breakdown of the key concepts covered:
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Limit Orders: These orders allow investors to specify a price at which they want to buy or sell a security. For instance, a buy limit order ensures purchase only at or below a specified price, while a sell limit order executes sales only at or above a preset price. Importantly, a limit order guarantees a price limit but not the execution.
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Stop Orders: Unlike limit orders, stop orders become market orders once a certain price (the stop price) is reached or surpassed. These orders are conditional and are primarily used as protection against losses or to secure profits. A buy-stop order triggers a market order once the price exceeds a specified level, while a sell-stop order activates when the price falls below the set threshold.
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Stop-Limit Orders: This order type combines features of both limit and stop orders. It requires two prices: a stop price and a limit price. When the stop price is reached, a limit order is activated, ensuring execution at the limit price or better. However, there's a risk of partial or no fills if the limit price isn't available.
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Differences and Applications: Limit orders allow control over pricing but risk non-execution. Stop orders offer protection but may lead to executions at less favorable prices. Understanding these differences helps investors choose the most suitable order types based on their trading objectives.
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Execution Strategies: Traders often use technical analysis tools like trendlines, Fibonacci levels, Bollinger Bands®, and other indicators to determine optimal entry or exit points for placing these orders. Analyzing market trends assists in deciding where to position these orders effectively.
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Risk Considerations: Stop orders, including stop-limit orders, carry the risk of partial fills or non-execution, while market orders from stop orders may not guarantee desired prices during execution, leading to potential losses.
Ultimately, using limit orders, stop orders, or their variations empowers traders by providing them with increased control and specific instructions for executing trades at desired price levels or in response to market movements.
In conclusion, understanding the nuances between limit orders, stop orders, and stop-limit orders enables traders and investors to employ effective strategies in navigating financial markets, managing risk, and optimizing trade executions.
