How To Use a Stop-Limit Order
T here are tips, tricks, and basic knowledge one should learn before taking the plunge into the stock market to be successful. Knowing what a stop-limit order is and when to use it is just one of those crucial tips. With a little more information on stop-limit orders, you’ll be able to watch your money grow or save your investment before it plummets. Take a look at some of the key factors that make up this useful order.
- A stop-limit order helps reduce risk in the stock market.
- Set both the stop price and the limit price on a particular stock to implement a stop-limit order.
- Conditions may pose a risk when implementing a stop-limit order.
- Learn the difference between a stop order and stop-limit order and when to execute each to be successful.
What Is a Stop-Limit Order?
A stop-limit order is a method used to reduce the risk when buying or selling stocks. This method uses the combination of a stop order and a limit order. A stop order is when you buy or sell a stock once it reaches or exceeds a particular price point. A limit order is when you buy or sell a stock when it falls to a set price.
To put a stop-limit order in place, you need to set both your stop price and limit price for a specific stock. Once you have determined the price point at which you would want to sell a stock, whether it be for a gain or loss, you’re ready to set up your stop-limit order.
Why Use a Stop Limit Order?
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The main reason for a stop-limit order is to gain more control over when to buy or sell shares. When the market is more volatile, you may want to have more control over your buying and selling decisions. If you own a share and notice that the price of that share is starting to decline, you could enact a stop-limit order so that your loss doesn’t spiral out of control. The same thing applies to when you’re looking to purchase a share. Enact a stop-limit order to make that purchase before the share gets too expensive.
Another reason you may want to enact a stop-limit order is when you can’t monitor your investments over a certain period of time. For example, if you’re going away on vacation and won’t have the time or ability to watch your stocks, you may want to put a stop-limit order in place before leaving. This could decrease the amount of money you could potentially lose if the market starts to drop. It could also allow you to buy stocks at a cheaper price before the market increases drastically.
Stop-Limit Order Example
Stock limit orders can be difficult to grasp. To demonstrate the process and outcome, let’s look at an example.
You own 100 shares in The 99Bottle Company, and the shares are currently valued at $10 per share for a total of $1,000 invested. You plan to go on vacation and won’t have the ability to monitor your investment while you’re gone. Before you leave, you set your stop at $7 and your limit at $5, just in case.
A negative financial report is released during your vacation, and The 99Bottle Company’s stock price drops to $7. This triggers your limit order. Other investors begin selling their shares, causing the price of the stock is about to plummet to $5. The limit order of $5 is fulfilled, making the investment now worth $500.
By the time you return from vacation, The 99Bottle company stock has dropped to $2 per share, and your total investment would have only been worth a stellar $200. Due to planning and taking control of your investment, you were able to salvage your investment before the price plummeted by enacting that stop-limit order.
How to Set Up a Stop-Limit Order
Setting up a stop-limit order is easy. Most trading platforms and brokers have stop-limit order options. First, monitor your shares and do your research. Then, submit your stop-limit order online or with your broker. Set your stop price (the price that will trigger your limit order). Set your limit price (the minimum or maximum that you are willing to sell or buy your shares for). Finally, set your time limit. A stop-limit order will remain in effect until the stop triggers or you cancel it unless you set up a time frame.
Risks of a Stop-Limit Order
There are many advantages to implementing a stop-order limit. However, with advantages, there always comes some disadvantages or risks. Knowing what some of the risks are will help you make a better decision when determining whether a stop-limit order is warranted or not and the ranges you need to implement.
Having a stop-limit order in place does not guarantee that execution will happen if the stock doesn’t reach or exceed the stop limit. Likewise, an order won’t be triggered if the stock falls past your absolute lowest price. At this point, you either need to sell the stocks at a lower price than what you want or hold onto them and hope the price rises again.
Another risk is having your stop-limit order partially filled. If you own 100 shares and only 40 of them were able to be filled during the stop-limit order, you would be stuck with the other 60 in an open order. When working with a brokerage, you may need to pay a commission on all executed trades. If you have multiple executed trades over a few days, you would pay a commission on each of those executed trades, costing you more money.
To combat some of these risks, you can specify certain conditions on your stop-limit order, such as:
- All or none, where either all of the shares are taken care of by the stop-limit order, or none are.
- Fill or kill, which provides that the entire order is filled or canceled if that’s not possible.
- Immediate or cancel, where the order is attempted to be filled immediately with any unfulfilled portion canceled.
Any of these conditions may reduce the chance of your stop-limit order being executed when the timing is wrong.
Stop Order Vs. Stop-Limit Order
W hile both a stop order and stop-limit order give you control over your shares, a stop-limit order provides more precision. In a stop order, your shares will sell once the stop price has been reached. It doesn’t matter how low or unfavorable the price goes. All your shares will sell at the market value. This can cause you to lose a substantial amount.
In a stop-limit order, your shares will begin to sell once the stop price is reached. However, the benefit of the stop-limit is that once the limit price is reached, the trade is halted. The limit order takes effect to ensure that the trade is only completed when the price is at your limit price or better. You won’t sell or buy a share for more or less than what you have specified.
Stop-limit orders are beneficial to understand when investing in the stock market. They give you control over your investments, allowing you to set up the parameters for both buying and selling. When you’re going to be away from the computer and cannot monitor your stocks, implementing a stop-limit order could also save you money. If you hear rumors that one of your investments could be struggling, implementing a stock-limit order could save you money. Stop-limit orders are quick and easy to submit either online or with your broker.