Stop limit order: When should you use it during trading and the its risks
Every investor wants to limit the risk of their investments. And that’s when Stop limit order comes in. It is the tool to help investors minimize the risk and avoid great loss of money. Now, let’s take a look of this useful tool
What is Stop limit order?
Described in the name, it is the combination tool of “ Stop order” and “ limit order”. This tool can minimize the risk and avoid the potential uncertainty about the order’s execution price. In simple term, to use it, investors first have to determine the stop price and the limit price
When the market price is equal or higher than the stop price, the stop order will become the limit order.
Here is an example. You want to sell 100 shares of A company. Then, you set the stop price at $250/share and the limit price at $240/ share. After that, your sell order will be activated at the price of $250/ share or lower. However, when this price go lower than $240/ share, the sell order will be stopped.
Risks of Stop limit order
The trading might not be executed
When the price drop down lower than limit price, you will expect it to recover soon. However, what if the order expires before the price recovery? Then, you will have to use market order or stop order to sell stock with much lower price than you expected.
As a result, for stock selling, this order will extremely risky
Partially filled orders
This is one of the common concerns when it comes to stop limit order. For example, you want to sell 500 shares. However, the price drop down below your limit price when you’ve only sold 400 shares. Then, you have 100 shares left unfilled.
If you want to fully fill your order, you can consider using stop loss order.
Stop limit order vs Stop loss order
Both stop limit order and stop loss order are stop orders you use to sell shares. However, there are some dramatic differences between these two. You now have some understanding about stop limit one. Let’s dive into stop loss order
What is stop loss order
It is an order placed with a broker to buy or sell shares at a certain price. The main purpose of stop loss order is to protect the investor’s position in security.
Also, it different from stop limit order. When the price is lower than stop price, the order will become market order and execute at next available price. There is not limit price in this case
To illustrate, a trader buy a stock and set the stop loss order 10% lower than the buy price. Then, when the stock price decrease, the stop loss will. After that, the stock will be sold as market order.
How to choose the right order?
Both stop limit order and stop loss order can bring great benefits to investors and traders. However, you can’t have a cake and it it. Each one still has its own drawbacks. Therefore, investors and traders need to consider carefully before choosing which.
Stop limit order can protect you from the loss price slippage with limit price. However, the trade may not be executed.
On the other hand, stop loss order can grant you the execution, but not price. The main reason of this order is protecting investor’s position in security.
So, how can you choose the right order for your investment? To do this, first, you need to assess the situation of the stock. If stock price is unstable, or fluctuating, then stop limit order will be the right option. It can guarantee the price for you. Thus, investors can avoid losing a great sum of money. Even if the trading doesn’t happen, you only have to wait for a moment for the price to increase again
On the other hand, stop loss order will be suitable with companies having doubt upon its long-term. The main reason is the long recovery of the stock price. The price might not return to its current level in a short time. If you use stop limit order, you might get a great loss since the trading isn’t executed.
For both stop limit order, the key factors are stop price and limit price. You shouldn’t set the limit price too close to stop price, for example, only $1 or $2. Otherwise, your trading will stop soon due to small margin and miss out when the price starts to rise again
Nothing is perfect. Although both stop limit order and stop loss order have great benefits, they can fully meet all investors’ requirements. As a result, to minimize the risk, you need to assess the stock carefully before choosing order.
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