A stop-limit order is a strategic trading tool that combines the attributes of stop and limit orders to help mitigate risk. This type of order is prevalent among traders who want a precise level of control when executing trades.
Key Takeaways
- Stop-limit orders merge features of stop and limit orders to manage risks more effectively.
- Traders gain precise control over be order’s execution, though it is not always guaranteed to be filled.
- The stop price triggers the order, converting it to a limit order at the set limit price or better.
- They are designed for risk management, automation, and trade flexibility but may not protect against price gaps and involve complexity.
- Useful for locking in profits and limiting downside losses.
How Stop-Limit Orders Work
The allure of the stop-limit order lies in the precision it offers traders. Here’s how it works:
- Set Your Stop Price: This price level triggers the trade. If the security’s price touches or falls below this point, the stop-limit order activates.
- Set Your Limit Price: This is the maximum buying price or minimum selling price at which you are willing for the order to be filled. After activation, the order turns into a limit ordercimadic and only trades at your specified price or better.
- Select Time Frame: Define the time within which the order should be executable.
It’s crucial to note that stop-limit orders don’t guarantee that your trade will be executed, especially if prices move sharply or there’s a trading gap.
Features of Stop and Limit Orders
- Stop Order: Executes when a specific set price is reached and is filled at the current market price. These are often guaranteed execution but lack price protection.
- Limit Order: Executes only at a specified price or a better one, stopping if market conditions turn unfavorable.
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Pros of Stop-Limit Orders
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Related Terms: limit orders, stop orders, market orders, stop-loss orders.
References
- U.S. Securities and Exchange Commission. “Investor Bulletin: Understanding Order Types”.
- Jordan, Douglas, and J. David Diltz. “Day Traders and the Disposition Effect”. The Journal of Behavioral Finance, vol. 5, no. 4, 2004, pp. 192-200.
- NYSE. “Holidays & Trading Hours”.
- Nasdaq. “Trading Hours for the Nasdaq Stock Markets”.
- U.S. Securities and Exchange Commission. “Trading Basics: Understanding the Different Ways to Buy and Sell Stock”. Page 3.
