What Is a Stop Limit Order?

A stop limit order is a type of order used in trading that combines a stop order and a limit order. A stop order is an order to buy or sell a security once it reaches a certain price, known as the stop price. A limit order is an order to buy or sell a security at a specified price or better. A stop limit order combines these two types of orders by specifying a stop price and a limit price.

Pros and Cons of Stop Limit Orders

Stop limit orders have several advantages and disadvantages that traders should consider when deciding whether to use them in their trading strategy.

Pros:

1. Control over execution price: Stop limit orders allow traders to set a specific limit price at which they want the order to be executed, which can help them control the execution price and potentially get a better price than with a market order.
2. Risk management: Stop limit orders can be used to manage risk by setting both a stop price and a limit price, which can help traders limit losses and lock in profits.
3. Flexibility: Stop limit orders can be used for a variety of trading strategies, such as entering a position at a breakout or exiting a position at a specific price.

Cons:

1. Complex execution: Stop limit orders can be more complex than other types of orders, as they require careful consideration of both the stop price and the limit price to ensure the desired execution.
2. Liquidity: Stop limit orders may not be filled if there is insufficient liquidity at the limit price, which can result in missed opportunities or unexpected losses.
3. Timing: Stop limit orders can be vulnerable to sudden market fluctuations or volatility, which can trigger the stop order and result in unexpected losses.

In summary, stop limit orders can be a useful tool for managing risk and optimizing trading strategies, but traders should be aware of the potential risks and use appropriate risk management techniques. It’s important to carefully consider the stop price, the limit price, the size of the position, and the level of liquidity in the market when using stop limit orders.

Stop Limit Order Examples

Here are two examples of how a stop limit order works:

1. Buy Stop Limit Order: A trader holds a short position in a security and wants to limit their losses. They set a stop price above the current market price, say at $50, and a limit price at $51. If the market price reaches $50 or higher, the stop order is triggered and becomes a limit order to buy at the limit price of $51 or lower. This can help the trader limit their losses while still maintaining control over the execution price.
2. Sell Stop Limit Order: A trader holds a long position in a security and wants to lock in profits. They set a stop price below the current market price, say at $70, and a limit price at $69. If the market price falls to $70 or lower, the stop order is triggered and becomes a limit order to sell at the limit price of $69 or higher. This can help the trader lock in profits while still maintaining control over the execution price.

Stop Limit Order vs. Stop Market Order

A stop limit order and a stop market order are both types of orders used in trading that involve setting a stop price. However, there are some key differences between the two.

1. Control over execution price: Stop limit orders provide more control over the execution price than stop market orders, as traders can specify a limit price.
2. Potential for execution: Stop market orders are more likely to be executed than stop limit orders since stop market orders are executed at the current market price once the stop price is reached.
3. Risk management: Stop limit orders can help manage risk by specifying the maximum or minimum price at which a security is bought or sold, while stop market orders do not offer this type of control.
4. Complexity: Stop limit orders can be more complex than stop market orders because traders need to consider both the stop price and the limit price.

Overall, traders should consider their specific trading goals and risk tolerance when deciding whether to use a stop limit order or a stop market order. Stop market orders may be more appropriate for traders who prioritize speed of execution, while stop limit orders may be more appropriate for traders who prioritize control over execution price and risk management.

The Bottom Line

Stop limit orders are useful for traders who want to control the price at which they buy or sell a security. They allow traders to limit their losses or lock in profits by combining a stop order with a limit order. However, it’s important to note that stop limit orders can be more complex than other types of orders and require careful consideration of the stop and limit prices to ensure the desired execution.