Stop-Loss vs. Stop-Limit: An Overview

Traders will often enter stop orders to limit their potential losses or to capture profits on price swings. These types of orders are very common in stocks and especially 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.

Key Takeaways

  • Stop orders are used by traders to limit downside losses, where a sell-stop order protects long positions by triggering a market sell order if the price falls below a certain level.
  • Stop-limit orders are a type of stop-loss, but at the stop price, the order becomes a limit order instead of a market order, only executing at the limit price or better.
  • The risk of a stop-limit is that the stop may be triggered but the limit is not, resulting in no execution.

Stop-Loss Strategy

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 potential losses by exiting at a price of $25, they would enter 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.

Note that a stop-loss can also be used by short sellers where the stop triggers a buy order to cover rather than a sale.

A stop-loss is common, and in its basic form converts into a market order to sell once the stop price is triggered. However, in a fast moving market, the market order may be less than ideal, leading to larger losses than anticipated. One solution is to modify the stop order into a stop-limit order.

Stop-Limit Orders

A stop-limit order is technically two order types combined, having both a stop price and limit price that can either be the same as the stop price or set at a different level. 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, the 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 end up being triggered but then 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.


Stop Limit Orders

The Bottom Line

Stop-loss and stop-limit orders can provide different types of protection for both long and short investors. Stop-loss orders guarantee execution, while stop-limit orders guarantee the price.