Should You Use Stop-Limit Orders?
Would you have better results if you used stop-limit orders in your stock market transactions?
Retail traders are finding there are fewer hours where they can watch stock prices. If you aren’t always monitoring your portfolio, but you have predefined entry and exit scenarios, and you aren’t yet using this order type, you may want to consider it. Novice to advanced investors enter potential trades this way for a number of reasons including to automate trading, locking in profits, and minimizing losses.
Stop-Limit Order Characteristics
Stop orders become automatically triggered as a live order once a set price has been reached. It is then a market order and is expected to be filled at the current market price. The stop order is filled in its entirety, even if that means there are different prices for various pieces of the order.
Limit orders are orders that are set at a target price. The order is only executed when the stock hits the limit price or at a price that is considered even more preferred than the account holder’s limit price. If price movements cause the price to move against the initial limit price, even after it receives a partial fill, the order will stop executing.
By combining the two orders, stop orders and limit orders, the investor doesn’t place as much control in the market, instead they retain some level of precision to help follow their plan.
Stop-Limit Order Usage
The primary reason a trader will enter a stop-limit order is to have precise control over when the order should be sent out to be filled. A possible downside with all limit orders is that the trade may never get executed if the stock does not reach the stop price during the specified time period.
A stop-limit order requires the setting of two price points, both the stop price and the limit price. This makes sense for those that don’t wish to get filled in a volatile market at a price in the opposite direction of the stop. The trader first sets a stop price, which is the price they want the trade to be triggered. Then, the limit price they want to execute at is set. This price is used to limit the maximum price they will pay or the minimum price they will receive if the trade is executed.
A time frame must also be set during which the stop-limit order is considered executable.
The stop-limit order will be executed at a specified price, or better after a given stop price has been reached. Once the stop price is reached, the stop-limit order becomes a limit order to buy or sell at the limit price or better. This type of order is an available option with nearly every online broker.
Downside
It’s important to note that stop-limit orders do not guarantee that your trade will be executed. If the price of the security drops quickly or there is a gap in trading, the order may not be filled at the desired limit price or at all. This may result in missed opportunities for profit should the appropriate prices not be targeted.
Opportunity cost can be another downside. There is no guarantee that the stock will ever reach the price of execution. In the meantime, you may not be acting on other opportunities as you wait to see if the market will go your way.
And, what does happen from time to time, if the price gaps or moves quickly, the order may not be executed at all. This can be especially problematic in fast-moving markets where prices are volatile.
There are retail and professional traders that know about stop-limit orders, would benefit, yet get lazy, or figure they are watching it trade by trade so they’ll just pull the trigger when need be. This leaves open the chance they may not execute their strategy.
Upside
With a stop-limit order, you control the price at which you enter or exit a position. This means that you can set a limit price that is higher or lower than the stop price, depending on whether you are buying or selling. This gives investors greater control over the execution price and allows the order to go in before the stock reaches it, which makes it more likely their order will be closer to the front of the line.
You need not watch it. The orders will automatically be sent when the stop price is reached. This means that you don’t have to monitor the market constantly and can let the order execute on its own. This is useful for more passive investors.
More sophisticated strategies can also benefit. Stop-limit orders can be used in a variety of trading strategies, including day trading, swing trading, and position trading. They can be used to enter or exit a trade, and they can be used for both long and short positions. This flexibility makes stop-limit orders a versatile tool for traders regardless of the style of trading that investor wants to adopt.
Take Away
Many self-directed investors found they had ample time to monitor their trade orders during the Covid lockdowns and they now are trying to continue to be active in the markets. The characteristics of the stop-limit order may help them stay active.
Managing Editor, Channelchek