Traders often enter stop orders to limit losses or capture profits on price swings. These types of orders are very common in forex trading, where small swings can equal big gains for traders but are also useful to the average investor with stock, option or forex trades. There are two similar-sounding order types that are slightly different. The first, a stop order, triggers a market order when the price reaches a designated point. A stop limit order is a limit order entered when a designated price point is hit.
A stop order is commonly used in a stop-loss strategy where a trader enters a position but places an order to exit the position at a specified loss threshold. For example, if a trader buys a stock at $30 but wants to limit his or her losses by exiting at a price of $25, he or she enters a stop order to sell at $25. The stop order triggers if the stock falls to $25, at which point the trader's order becomes a market order and is executed at the next available bid. This means the order could fill lower than $25 or higher, depending on the next bid price.
A stop-limit order is technically two order types combined, having a stop price and an equal or different limit attached. When the stop price is hit, the trader's limit order is entered. For example, if the trader in the previous scenario enters a stop at $25 with a limit of $24.50, his or her order triggers when the price falls to $25 but only fills at a price of $24.50 or better. This type of order, depending on the limit price entered, could trigger but not fill. It is possible the price could fall through the limit price before filling the entire order, leaving the trader with remaining shares at a greater loss than anticipated.