You've decided to invest your cash in stocks, hoping for a strong return. You’ve conducted your research and feel that you are ready to invest by implementing a limit order. You’ve found a company that is set to trend according to news sources and consider it an excellent opportunity for investment. You determine a limit order price by the closing stock price that day, and you set what you feel is a reasonable limit order and are confident in your decision. Then, you check the stock the next day, only to find that your order was unable to be filled because the stock took a sharp increase in price upon the market opening. 

The above scenario described is a prevalent one and can be frustrating for any investor. Many traders, identifying a potentially profitable setup, will place a limit order after hours so their order will be filled at their desired price, or better when the stock market opens. The problem is that many buyers do the same thing, and the increased demand can cause the price of the stock to gap higher. 

Key Takeaways

  • When too many buyers have the same idea, a limit order becomes ineffective because the price of the underlying asset jumps above the entry price.
  • A buy stop order is a type of order transformed into a market order once the stated stop price has been reached.
  • The downside of a buy stop order is that you may end up paying more than you expected if the opening day price is higher than you had estimated it would be.
  • An order that is made above the current market price is known as a buy-stop-limit order.
  • A buy-stop-limit order protects you from overpaying by setting a minimum and maximum limit price.

A limit order is ineffective when the price of the underlying asset jumps above the entry price. This is because the limit price is the maximum amount the investor is willing to pay, and in this case, it is currently below the market price.

You can minimize the chances of this situation happening again if you understand two types of orders: the buy stop order and the buy-stop-limit order.

What Is a Buy Stop Order?

A buy stop order is a type of order transformed into a market order once the stated stop price has been reached. To explain how this works, let's consider a hypothetical example.

Let's say that the current price of XYZ Company is $12.86, and it looks like it is positioned to go higher. You may wish to place a buy stop order with the stop price set at $13.01. This order would turn to a market order once the market price rose above $13.01. By using this type of order, you would eliminate the problem of not getting filled when the price rises above your desired entry price.

Unfortunately, by using this order, you run the risk of getting filled at an unwanted level if the price surges drastically higher. For example, if the price of XYZ Company opens the next day at $17, the buy stop order will be triggered, and you will buy the shares for around $17 instead of around $13, as you had planned for.

Buy-Stop-Limit Order

Using an order known as a buy-stop-limit is a way for you to eliminate the chance of getting a bad fill and limit the price paid for the asset. A buy-stop-limit order is similar to the buy-stop order, except that a limit price is also set as the maximum amount the investor is willing to pay.

For example, assume a buy-stop-limit order is placed on XYZ Company with a stop price at $13.01 and a limit price set at $15. If the price jumps to $17, this order will not get filled because you specified you don't want to pay more than $15.

The Bottom Line

Entering the market at a specific price can be a difficult move to time. It may result in missing opportunities or getting in at the wrong point based on your research.

Utilizing the buy stop order and the buy-stop-limit order can help you buy your stock at the prices you see value at. Once you are comfortable with these order types, you will increase the likelihood of your orders getting filled when and how you want them to be filled.