What is a Stop-Limit Order
A stop-limit order is a conditional trade over a set timeframe that combines the features of stop with those of a limit order and is used to mitigate risk. The stop-limit order will be executed at a specified price, or better, after a given stop price has been reached. Once the stop price is reached, the stop-limit order becomes a limit order to buy or sell at the limit price or better.
How Do Limit Orders Work?
BREAKING DOWN Stop-Limit Order
A stop-limit order requires the setting of two price points. The first point initiates the start of the specified action, referred to as the stop, while the second represents the outside of the investor’s target price, referred to as the limit. A timeframe must also be set, during which the stop-limit order is considered executable.
The primary benefit of a stop-limit order is that the trader has precise control over when the order should be filled. The downside, as with all limit orders, is that the trade is not guaranteed to be executed if the stock/commodity does not reach the stop price during the specified time period.
Features of Stop and Limit Orders
A stop order is an order that becomes executable once a set price has been reached and is then filled at the current market price. A traditional stop order will be filled in its entirety, regardless of any changes in the current market price as the trades are completed.
A limit order is one that is set at a certain price. It is only executable at times the trade can be performed at the limit price or at a price that is considered more favorable than the limit price. If trading activity causes the price to become unfavorable in regards to the limit price, the activity related to the order will be ceased.
By combining the two orders, the investor has much greater precision in executing the trade. A stop order is filled at the market price after the stop price has been hit, regardless if the price changes to an unfavorable position. This can lead to trades being completed at less than desirable prices should the market adjust quickly. By combining it with the features of a limit order, trading is halted once the pricing becomes unfavorable, based on the investor’s limit.
Example of a Stop-Limit Order
For example, assume that ABC Inc. is trading at $40 and an investor wants to buy the stock once it begins to show some serious upward momentum. The investor has put in a stop-limit order to buy with the stop price at $45 and the limit price at $46. If the price of ABC Inc. moves above $45 stop price, the order is activated and turns into a limit order. As long as the order can be filled under $46, which is the limit price, the trade will be filled. If the stock gaps above $46, the order will not be filled.