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What is the difference between a stop, and a stop limit order?

Some of our viewes write to me to explain who to invest in the stop market without lossing their shirts. To prevent yourself from losing everything in the events of a black swan event, a stop loss and stop limit order is a necessity. Read below the difference between the two and execute the order as suitable to your portfolio.

Stop orders are the simpler of the two.  Stop orders are triggered when the market trades at or through the stop price (depending upon trigger method, the default for non-NASDAQ listed stock is last price), and then a market order is transmitted to the exchange.  A buy stop is placed above the current market price.  A sell stop order is placed below the current market price.  Stop orders may get traders in or out of the market.  The risk associated with stop orders is that they don’t guarantee a price.  When a buy stop order triggers, the market order is transmitted and you will pay the prevailing ask price in the market when received.  When a sell stop order triggers, the market order is transmitted and you will pay the prevailing bid price in the market when received. 

Stop limit orders are slightly more complicated.  Account holders will set two prices with a stop limit order; the stop price and the limit price.  When the stop price is triggered, the limit order is sent to the exchange.  A limit order will then be working, at or better than the limit price you entered.  With a stop limit order, traders are guaranteed that, if they receive an execution, it will be at the price they indicated or better.  The risk associated with a stop limit order is that the limit order may not be marketable and, thus, no execution may occur.  A sell stop limit order is placed below the current market price.  When the stop price is triggered, the limit order is sent to the exchange and a sell limit order is now working at, or higher than, the price you entered.  A buy stop limit order is placed above the current market price.  When the stop price is triggered, the limit order is sent to the exchange and a buy limit order is now working at or lower than the price you entered.

Stop Loss Order Example:

For example, let’s say a trader owns 1,000 shares of ABC stock. They purchased the stock at $30 per share, and it has risen to $45 on rumors of a potential buyout. The trader wants to lock in a gain of at least $10 per share, so they place a sell-stop order at $41. If the stock drops back below this price, then the order will become a market order and get filled at the current market price, which may be more (or more likely less) than the stop-loss price of $41. In this case, the trader might get $41 for 500 shares and $40.50 for the rest. But they will get to keep most of the gain.

Stop Limit Order Example:

For example, let’s assume ABC stock never drops to the stop-loss price, but it continues to rise and eventually reaches $50 per share. The trader cancels his stop-loss order at $41 and puts in a stop-limit order at $47 with a limit of $45. If the stock price falls below $47, then the order becomes a live sell-limit order. If the stock price falls below $45 before the order is filled, then the order will remain unfilled until the price climbs back to $45.

Many investors will cancel their limit orders if the stock price falls below the limit price because they placed them solely to limit their loss when the price was dropping. Since they missed their chance to get out, they will then simply wait for the price to go back up and may not wish to sell at that limit price at that point in case the stock continues to rise.

Another Real World Example of a Stop-Loss Order

A trader buys 100 shares of XYZ for $100 and sets a stop loss order at $90. The stock declines over the next few weeks and falls below $90. The traders stop order gets executed and the position is sold at $89.95.

A trader buys 500 shares of ABC Corp. for $100 and sets a stop loss order for $90 again. This time the company reports horrible earnings results and the stock plunged by over 50%. When the market re-opens the traders stop order is triggered, and the trader gets executed at a price of $49.50. 

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