What Is a Stop-Limit Order?
A stop-limit order is a tool that is used to help traders limit their downside risk when buying or selling stocks. To do this, it combines two other types of orders: a stop order and a limit order.
- A stop order initiates a market order to buy or sell a security once it reaches a certain price (the stop price).
- A limit order is an order to buy or sell a security at a specific price (or better).
The trader starts by setting a stop price and limit price, then submits the stop-limit order. Once the security reaches the stop price, a limit order is triggered to buy or sell the security (whichever is specified by the trader) for the limit price or better.
How Do Stop Limit Orders Work?
For traders, stop-limit orders provide more control over their transactions by establishing minimum or maximum prices for orders. The trader can do this by setting two prices: a stop price and a limit price.
Stop price: The price that triggers the stop limit order
Limit price: The minimum/maximum price that security will be bought or sold for
If the price of the security reaches the stop price, the limit order is triggered and automatically attempts to buy or sell the security at the limit price or better.
When to Use a Stop Limit Order
Stop limit orders are used when traders want the most control over their transactions. This makes them useful for both buying and selling securities. Stop limit orders also help to reduce the risk for long-term investors and short-sellers by controlling when orders are placed and the minimum/maximum prices that securities can be bought and sold for. This is especially useful in volatile markets where prices can fluctuate rapidly or when traders can’t constantly monitor their transactions.
Stop Limit Order Example
An investor currently owns 100 shares of Company QWE. The shares are currently valued at RS.500 per share, so the investment is worth a total of RS. 5,0000. The company’s financial reports are due to be released within the next week, but there are rumours that there will be bad news. The investor is going on vacation for two weeks and has no way to monitor their investment. To limit potential losses, the investor submits a stop-limit order with a stop at RS. 450 and a limit at RS. 420.
Once the financial reports are released, the price of the stock drops to RS. 450, triggering the limit order. Many other investors begin selling off their shares, further reducing the price of the stock. Eventually, the limit order is fulfilled at RS.430 per share, so the investment is now worth RS. 43,000.
When the investor returns from vacation, she /he discovers that the stock is now trading at RS. 330 per share. Had the stop limit order not been in place, the investment would only have been worth RS. 33,000.
