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Stop Loss vs. Stop Limit Orders: What’s the Difference?

W hen stock traders want to limit their potential losses, they can use a few different types of stock orders to move into and out of positions in the market when they might not be able to place a trade order themselves. In this situation, stop-loss orders and stop-limit orders become highly valuable tools for initiating trades automatically.

While stop-loss and stop-limit orders are related, there are a few key differences in how these order types are executed. We’ll cover these differences and more in this guide on the difference between stop loss and stop limit.

Key takeaways from this guide:

  • Stop-loss orders help traders reduce the amount of loss they can potentially take on when trading their position on a particular stock.
  • Stop-limit orders only sell stocks at a set price or higher and will only purchase stocks that are at or below a set price.
  • One of the biggest difference between stop limits and stop losses is that stop limits contain two price points, the limit price and the stop price.

What Are Stop-Loss Orders?

Image via Unsplash by Chris Liverani

A stop-loss order is a type of order that stock investors use to reduce the amount of loss they may take on a given position they have on a particular stock.

A stop-loss order automatically sells your position in a stock when it hits a specific price point. The order converts to a market order as soon as the stock price reaches your stop-loss price. Once the stop loss converts to a market order, its execution is guaranteed, but its price isn’t. Ultimately, the stop-loss order is designed to limit a trader’s losses when investing in the market.

When a trader places a stop-loss order, it gives them a limited downside. So, if a stock trader purchases an order to take a position on a stock, a stop-loss order would give the investor an idea of how much downside they’re willing to take on.

As an example, investors could use a stop-loss order to buy a stock and then initiate the sale of the asset if it drops below a certain price point. Let’s say a stock trader wants to buy a stock for $10 per share and places a stop-loss order to sell if the price drops below $8. Once it reaches that price, the stock will convert to a market order, which then sells immediately.

With that said, the price the stock sells for isn’t guaranteed. For example, if the stock falls further than the $8 trigger point between the time it’s converted to a market order and the time it actually sells, then you may end up with a higher amount of loss. However, if the stock slightly recovers its value in that time, such as jumping back up to $9, it would still be a loss, but it would be a smaller loss.

What Are Stop-Limit Orders?

A stop-limit order is a combination of a stop order and a limit order where you set a condition to buy or sell a stock once it reaches the stop price. Traders use stop-limit orders as a buffer against the unpredictability of the stop-loss orders they place. Because stop-loss orders convert to market orders as soon as they’re initiated, traders could potentially execute a trade at a very unpredictable value. For example, if you place a stop-loss order to initiate when the stock hits $10 per share, you don’t have control over the price it actually sells for.

In this case, a stop-limit order will convert to a limit order rather than a market order, instructing your broker to buy or sell stocks at a specific price or better. A stop-limit order will only sell stocks that are at your set price point or above and will only purchase stocks that are at or below the price point you set.

Stock traders can use a stop-limit order to buy stocks in a short position by issuing an order to purchase a security if it rises above a specific stop price. They can also instruct the broker not to buy the stock if it goes higher than the set limit price.

Understanding the Difference Between Stop Loss and Stop Limit

Before placing any orders in the stock market, it’s important to understand some of the main differences that distinguish stop-loss orders from stop-limit orders. First of all, a stop-loss order stays dormant — that is, it doesn’t activate as a market order until the asset reaches a specific price.

To understand how this works, let’s take a look at another example. If you were to place a stop-loss order on a stock for $50 per share, the order wouldn’t actually be put into a trade until the price hit or fell below $50. After that point, the order converts to a market order, and your shares would sell at the best price possible. A stop-loss order is guaranteed to trade and become a transaction.

Stop-loss orders are highly advantageous for investors who don’t have a lot of available time to keep an eye on the market every day but who also need that added protection in case there’s a significant downturn in the market.

Unlike stop-loss orders, stop-limit orders place a limit on the price that the order will convert to. A stop-limit order consists of two specified prices: the stop price, which will be the trigger that converts the stop-limit order to a sell order, and the limit price. Unlike a stop-loss order that immediately becomes a market order, a stop-limit order goes through a couple of phases.

First, it converts to a sell order. Then, it converts to a limit order that only trades at the specified limit price or higher. What this means for stock trading is that the transaction isn’t guaranteed.

Even though a stop-limit order can protect your stock portfolio from significant losses, it can also keep your portfolio from selling the security at all.

Placing Stop-Loss and Stop-Limit Orders

Both stop-loss orders and stop-limit orders can offer traders various types of protection against volatility. For one, stop-loss orders pretty much guarantee the execution of a stock sale, but the price can move up and down during execution. Stop-limit orders, on the other hand, can guarantee limits on a stock’s price, but that particular trade may never initiate. This can strap an investor to the asset with a significant loss in a quickly changing market if the order doesn’t fill before the market price drops below the limit price.

Additionally, choosing whether to place a stop-loss order or stop-limit order is another key difference, even though these two concepts are somewhat related. Before using either order type, however, you need to evaluate how the stocks are trading. For example, a volatile market with significant movements in stock prices may be an indicator for traders to use a stop-limit order to lock in stock prices. Then, if the trade isn’t initiated, the trader might only have to wait a little while for the stock price to jump again.

A stop-loss order would be a trader’s choice if they heard negative feedback about a company that created doubt about its long-term success and growth. This could be because the stock price might not return to its current price for a long time, or it might never recover at all. In this case, traders would most likely cut their losses and accept the market value of the stock.

Another main difference in placing stop-loss and stop-limit orders is setting the price. Traders may use technical analysis to evaluate stop-loss prices because they are frequently placed at various levels of technical resistance or support. Stock traders who place stop-loss orders on stocks that continuously rise may also let the stock fall back a little. This is because if the stop price is too close to the current price, they may be stopped out due to the small difference in price.

Choosing Between a Stop Loss and Stop Limit

When choosing between a stop-loss and a stop-limit order, there are several key factors to consider. You can also discuss the best order types for your portfolio with a stockbroker. When stock traders choose to place stop-loss and stop-limit orders, they typically look at:

  • Risk.
  • Volatility.
  • Price.

Looking at these factors through a technical analysis gives traders a clearer picture of which order to place for their investments. Additionally, the order type an investor chooses will be dependent on the stock’s health — that is, how well it’s trading on the market. Essentially, the choice between a stop loss and stop limit will boil down to the trader’s position in the market and whether they want to set an automatic trade for times when they aren’t on top of market activity.

Talk with your stockbroker about your trades to determine which order type will benefit your portfolio the most. With the proper tools and resources, you can use both order types to improve your portfolio and make significant returns on your investments.