What’s the Difference Between Stop-Limit and Stop-Loss Orders?
One of the most fundamental aspects of building an investment portfolio is an order. A market order allows the buyer to sell or purchase an asset immediately. Some orders are triggered when an asset hits a specific price. A limit order will trigger either a purchase or a sale if a selected asset hits at or above a specific price. A stop order will begin a sale or purchase if a fixed asset hits at or below a specific price.
There are two main stop orders in the stock market: a stop-limit and a stop-loss. It’s important to know what each means, the differences between them, and how you determine the appropriate time to use each.
With the right knowledge on stop-limit vs. stop-loss orders, you’ll be able to make the best use out of your portfolio investments.
- A stop-loss order helps avoid getting stuck in long positions by triggering a sell if the price drops below a certain level.
- Buy-stop orders will trigger if the current price rises above the current market price in a short position.
- Stop-loss orders can help protect against extreme volatility in price and limit loss in fast-moving markets.
- A stop-limit is similar to a stop-loss, but with a limit on the price for executing the order. It’s important to note that there’s no guarantee that an order will be filled due to the rising and falling stock prices.
- A stop-loss will guarantee an order’s execution, while a stop-limit order will guarantee the price.
What Is a Stop-Loss Order?
A stop-loss order helps investors avoid getting stuck in long positions by triggering a sell if the price drops below a certain predetermined level. The underlying theory is that if that price has fallen this far, it may continue to fall further, which would cause an even more significant loss. Your loss is capped if you sell at the specified price.
For example, you own 1,000 shares of XYZ stock that you purchased for $20 per stock. The price has risen to $35 with a potential impending buyout. If you want a gain of at least $12 per stock, you could put a stop-loss order in place at $32. If the stock were to drop below that $32 price, the order would become a market order and be filled at the current market price. This price may be more or less than the stop-loss price that was specified, in this case, $32. You may get $32 for 500 shares and $31 for the other 500 shares. You still get to keep most of the gain in this example.
There are also buy-stop orders, which are essentially the same concept as the sell-stop orders. These are used to protect when you’re in a short position. By placing a buy-stop order, a purchase will be triggered if the order price rises above the current market price.
What Is a Stop-Limit Order?
A stop-limit is similar to a stop-loss, but with a limit on the price for executing the order. Two prices are specified in a stop-limit order: the stop price, which converts to sell order, and the limit price. In the case of a stop-limit order, instead of converting to a market order to sell, it becomes a limit order that’s executed only at the limit price or better.
Since there’s no guarantee that an order will be filled due to the rising and falling of stock prices, an investor will sometimes execute a stop-limit order because they’re not ready to sell and are willing to wait for the stock price to rise back up. This type of order is used for short sales.
Here’s an example of a stop-limit order with the same XYZ stock, just in a different scenario. Let’s say that it never drops to your stop-loss price and is continually rising until it reaches $40 per share, so the trader puts in a stop-limit order for $37 with a limit of $35. This stop-limit order means that if the stock price were to fall below $37, it would become a sell-limit order. If the stock price were to fall below $35 before the order is filled, it would remain unfilled until the price rises above $35.
Pros and Cons of Stop Orders
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Everything in the world of investment comes with its list of pros and cons. Stop-loss orders are no different. Stop-loss orders can help protect against extreme volatility in price and limit loss in fast-moving markets. They also provide you with a minimum price, but there’s no guarantee that a trade will be executed. If a trade using a stop-loss order does occur, it can come with a price change, often below the strike price. Remember not to base your order on emotion, as all orders are final.
A stop-limit order comes with a list of pros and cons as well. While a stop-limit order does not guarantee that a trade will be executed, it does allow the trader the ability to hold on to order for a period of time if the trade doesn’t execute due to the price guarantee. If the order isn’t filled before a price drop in the limit price, an investor could be facing a significant loss.
When to Use Stop-Loss vs. Stop-Limit Orders
A stop-loss order and stop-limit order both come with advantages, but timing is critical as with everything in investment. How do you determine when you should use a stop-loss order versus when you should use a stop-limit order? Both of these orders can be valuable investment tools when used correctly.
If you find a stock you want to invest in, consider if and when to add orders to your purchase. A stop-loss order would allow you to predetermine how much financial loss you’re willing to absorb. You set your limit before the purchase, and if the price exceeds that, then you’re done. If you can’t closely follow a stock to determine when it’s the appropriate time to close, this is a great option. Use this option when you are selling an order hoping to make a profit.
A stop-limit order may be better if the stock is more volatile and has a more substantial price movement. This type of order won’t be filled until the specified price becomes available. You can use a limit order to buy or sell a specified stock for a specified price.
Factors to Consider
Some special considerations when it comes to both stop-loss and stop-limit orders are as follows:
- A stop-limit order isn’t always executed and can either be partially filled or not filled at all. Your price limit may be triggered but remain unavailable.
- A stop-loss order doesn’t run the risk of a partial fill, but it can be filled at a price that is less than what you expected.
- Both the stop-limit and stop-loss orders can provide an investor with different kinds of protection when it comes to long and short-term investments.
- There’s never a one-size-fits-all when it comes to trading strategies. Mitigating risks and potential losses is essential when it comes to determining which order you’ll use.
- Never base any trade on emotion. Take the time to follow the stocks that you’re interested in purchasing. Base your trades on knowledge and skill instead.
There are many factors that affect trades in the stock market. As an investor, it’s essential to understand and consider those factors to be more in control of your order, regardless of which strategies you choose.
With the right background knowledge, the decision between using a stop-loss order versus a stop-limit order may be easier to determine. You should be well-versed enough in these orders to appropriately choose when and where to use each to your advantage. Remember that a stop-loss order will guarantee an order’s execution while a stop-limit order will guarantee the price.
A diversified portfolio paired with the knowledge of financial strategies and how to use them will help you develop the best investment plan possible. Whether you’re a beginning investor or have been in the game for a while, learning more about the stock market and how it works will only add to your profitability margin.