There are so many order types when it comes to trading … Today, let’s focus on one: stop-limit orders.
Are you looking for a way to get your orders filled at better prices?
Do you need help managing your risk while you’re away from your trading screens?
These are both smart reasons to learn how to use stop-limit orders. These can be helpful orders — especially for penny stock traders.
In this post, I’ll tell you all about what a stop-limit order is and when to use one. I’ll also cover some of the risks of using these orders. And I’ll share some tricks for getting better results with them.
Using the right order type can make a huge difference in your trading. Don’t skip this lesson.
Let’s dive right in!
Table of Contents
- 1 What Is a Stop-Limit Order?
- 2 Why Do Traders Use Stop-Limit Orders?
- 3 Stop-Limit Order Examples
- 4 When to Use Stop-Limit Orders
- 5 Stop-Limit Order Risks
- 6 3 Handy Stop-Limit Order Strategies
- 7 Conclusion
- 8 One Platform. One System. Every Tool
What Is a Stop-Limit Order?
The stop-limit order can be tricky to get your head around. It effectively combines parts of two order types: the stop order and the limit order.
With a stop order, you tell your broker, “when the price hits $x, buy (or sell) the stock.”
For example, you might want to hold XYZ stock if it breaks out above $10. You can set a stop order … And if price trades at $10 or higher, your broker will try to buy your shares, no matter the price.
On the other hand, with a limit order, you tell your broker, “Buy this stock at any price up to $x.”
For example, XYZ is trading at $8 and you set a limit order to buy 1,000 shares at a limit of $8.20. Your broker will buy up to 1,000 shares at any price under $8.20.
Here’s where we get to the stop-limit order, which combines both the stop and the limit order.
The stop-limit order triggers a limit order when a stock price hits the stop level.
For example, you might place a stop-limit order to buy 1,000 shares of XYZ, up to $9.50, when the price hits $9.
In this example, $9 is the stop level, which triggers a limit order of $9.50. Combining the two, we have the stop-limit order.
Stop-limit orders can be super helpful for trading if you can’t watch your trades all day. And they can be especially useful for stocks with thin trading volume, such as penny stocks.
Read on for more on how these orders work, plus when and how to use them.
Why Combine Both a Stop-Order and Limit-Order?
You may wonder what the point of using a stop-limit order is. Why not just use a stop-loss order?
Let’s look at an example to better understand stop-limit orders. Say you set a basic stop-loss order to sell 100 XYZ shares if the price declines to $10. The order means you’ll sell 100 shares at the market — no matter what the price is.
The trading volume on this stock is thin … There aren’t many current bids for the stock. You can get a terrible fill. So you end up selling your position for much less than $10. That can mean a larger loss than you anticipated.
Imagine that same situation, only this time you use a stop-limit order. You still want to sell 100 XYZ shares if the price drops to $10. But you enter a stop-limit order with a limit of $9.80.
Now if the price declines to $10, your broker will sell as many of the 100 shares as possible, down to a price of $9.80. You may be able to sell all of them or only a handful — but you won’t sell any below the $9.80 level.
There are a few key concepts to consider when using this order type. There are also various risks involved…
How Stop-Limit Orders Work
Once you enter a stop-limit order through your trading platform, the order is then placed on the order book at the exchange. The order remains there until it’s triggered, it expires, or you cancel it.
When you place the order, you decide how long it will be valid. You can select a good-til-canceled (GTC) order. That means it stays in the order book until it’s triggered or you cancel it.
Alternatively, you may only want the order to be filled in that day’s trading session. In that case, you’d use a day order to tell the exchange to cancel the order if it isn’t filled by the end of the day.
Stop-limit orders are only valid for standard market hours between 9:30 a.m. and 4 p.m. Eastern time. These orders aren’t filled in the after-hours or premarket sessions. These are generally times of extremely low trading volume.
Why Do Traders Use Stop-Limit Orders?
Let’s look at the kinds of situations in which you could use a stop-limit order. It’s important to note that you can use a stop-limit order in a variety of ways…
#1) To buy a stock: You can use the order to purchase a stock if the price hits a certain level.
#2) To short sell a stock: You can use the order to short sell a stock if price drops to a certain level.
#3) To stop-loss out of a long position. You can use the order to exit your long position if the price declines.
#4) To stop-loss out of a short position. You can use the order to exit your short position if the price rises.
With any of these four situations, you can use a simple stop-buy or stop-sell order. But if trading volume is thin, you can end up paying way too much or selling for way too little.
That’s why traders might use a stop-limit order. They can select the limit price at which they’re willing to buy or sell.
Stop-limit orders can be especially useful for part-time traders who can’t watch trades throughout the trading day. And this order type allows for specific criteria. That can help busy traders get a better fill without having to actively watch the order book.
Trailing Stop-Limit Order
When you buy a stock, and the price starts to move in your favor, it can be good to have a trailing stop-loss order in place.
This is an order that will constantly move your stop-loss up as price rises. For example, you may want a trailing stop order at 10% below the stock’s highest recent trading price. As the price moves up, your stop-loss order will follow the price up. It stays within 10% of the highest price.
Using a trailing stop can potentially help you profit from the upward move in the stock price. And you may be able to lock in profits if the price starts to decline.
The trailing stop-limit order works the same as the trailing stop-loss, but with a limit order attached to it. So if price drops to a certain level and you want to exit, your broker knows to sell the stock — but only down to the specified limit price.
Trailing stop-limit orders can be especially useful in low-float, penny stock runners. These are thinly traded stocks making big moves. The order type can help you protect your gains and also get a good fill if you need to stop out of the position.
Stop-Limit Order Examples
Let’s look at some real-world examples where a stop-limit order could be a part of a well-planned trading strategy.
Stop-Limit Buy Order Example
Looking at Microsoft’s chart, we can see that the stock’s in a long-term uptrend … But it recently had a pullback.
Let’s assume that you believe that the stock will soon bounce back and continue its uptrend. But you want to wait for the stock to get above its recent swing high before buying. A stop-limit order can help you with that.
You set a stop-limit order to buy 100 shares of MSFT at $189 (the blue line on the chart). You also set a limit of $190 and select GTC (good-til-canceled).
This means that you won’t have to watch the market action. If MSFT trades at $189 or above, your broker will buy you 100 shares up to a price of $190.
Stop-Limit Sell Order Example
In comparison to the previous example, let’s assume that you’re bearish on MSFT. You think its price is heading down, and you’ve decided to short sell the stock.
Before you take your short position, you want to see price trade below the stock’s recent swing low of $1.63.
You enter a stop-limit sell order to sell 100 shares of MSFT at a stop of $163 with a limit of $160, selecting GTC (good-til-canceled) in the order details.
This means that you can continue on with your life and not have to think much about the markets. If MSFT trades below $163, you’ll be entered into a short position at a price you’re happy with.
When to Use Stop-Limit Orders
Using specific order-types in certain situations all depends on your trading strategy. It’s up to you to build a trading strategy and determine the right order-types to use. That said, here are a few things to consider when using stop-limit orders…
#1) When you’re trading illiquid stocks: If you try to sell a position using a market order on a thinly traded stock, you can get filled 10%, 20%, or more away from the current market price. That’s because there’s not enough trading volume.
Having a limit on your order in an illiquid stock means your order may be gradually filled as buyers pop up throughout the session to purchase the stock.
#2) When you’re trading part-time: It’s just not possible for all traders to watch the market or order books all day.
The next best thing is to use semi-complex orders like stop-limits. They provide some additional peace of mind compared to a basic stop order.
Be warned though — there are risks involved. Let’s check those out next…
Stop-Limit Order Risks
Stop-limit orders can have some potential advantages. But this order type also has a number of downsides and risks.
Here are a few things to consider when choosing whether to use a stop-limit order.
#1) You May Not Get Filled
There will be situations where your stop gets triggered, but liquidity is so thin that the market trades straight through your limit price. Guess what? Your order isn’t filled.
It works like this: Imagine you own 1,000 shares of XYZ. You set a stop-limit order to sell if the price trades at $10, with a limit of $9.80.
Imagine that when the stock trades below $10 and your stop is triggered, there are no buyers of the stock … And the price quickly plummets to $9.60. In this cans, the stock is now trading below your limit price, but you’re still holding the losing position.
#2) You May Only Get a Partial Fill
Similar to the above example, your stop may be triggered and you’re looking to sell your 1,000 shares. But due to a lack of liquidity, you only sell a fraction of your position.
For instance, the price drops below $10. It’s a super-thin stock and you’re able to sell 100 shares. But the price quickly plummets to $9.60. You’re still holding 900 shares that are below your stop-loss level. This can turn a small loss into a large one.
#3) You May Pay a Larger Commission
Depending on your broker’s commission fees, you may pay more commissions if your order is filled in multiple parts.
So you may pay a minimum order fee to your broker for each trade. Your stop-limit order may be filled in three separate trades over multiple days due to the lack of liquidity. You can end up paying the minimum order fee three times. If you’d sold your position at market, you’d pay once.
These are some of the risks you need to weigh when determining whether to use a stop-limit order. Make sure to spend time developing a detailed trading plan, including order-types before entering any trades.
3 Handy Stop-Limit Order Strategies
#1) Use Charts to Determine Key Levels
It’s smart to set stop-limit orders where you expect other traders to buy and sell. These levels are often major support and resistance levels or previous key swing highs and lows.
Analyzing stock charts can be a great way to determine these key levels. You can use the horizontal line tool on your charting platform to look for areas where the market historically turns around.
Once you locate these key levels, it’s often a good idea to place your orders around them. Often you can expect liquidity to pick up as the price approaches them.
#2) Consider the Stock Volatility When Setting Your Limit
Selecting the right limit amount for a stop-limit order is both an art and a science.
If you set your limit too tight, you’re less likely to get a fill. If you set your limit too loose, you might pay a bad price. That can hurt you with bigger losses or smaller gains.
It’s important to consider the stock’s volatility. The more volatile, the wider limit you want to have.
#3) Keep an Eye on Trading Volume and Liquidity
It’s important to analyze a stock’s trading volume when determining whether to use a stop-limit order. It’s also smart for deciding where to place your limit.
If a stock has a huge amount of liquidity historically, you may be better off using a stop-order without a limit. You can reasonably expect that liquidity will be there.
If the stock’s too illiquid, it may be a good idea to lower your position size. That can allow you to more intelligently manage your risk.
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Stop-limit orders can be useful for active traders, especially those who trade penny stocks with thin volume.
A lot of newbies skip learning about order types. But the reality is that they can be a part of a smart trading strategy. I think it’s good to understand them. It can give you more insight into how other traders are navigating the markets…
The stop-limit order is just good to know, especially as it relates to volatility and trading volume.
When you’re ready, you might want to try using an order on a trade or two. If so, start small and see how it goes.
And if you don’t have a trading platform, grab your 14-day trial of StocksToTrade for $7. We’ve got you covered with just about every trading tool.
What’s the most common order type you use? Why do you use it? Tell me below!