What is a Stop-Limit Order?
Stop-Limit Order is a combination of Stop and Limit order which helps to execute trade more precisely wherein it gives a trigger point and a range. Say you want to buy when the stock price reaches $50 and you buy till it is $55. So the Stop-Limit order gets triggered when the price reaches $50 and it will continue to buy till the price remains below $55.
Stop Limit order consists of two features.
- Stop:- It is the trigger point where the order will be activated. It will have to be set outside the market price or else it will be triggered immediately after placement.
- Limit:- Limit means range, Stop will indicate the starting point of the trade and limit will indicate the closing point of the trade.
How does it Work?
Two prices are provided for Stop-Limit Order. When you see that a particular stock is trading in the market and you feel that the stock price will rise in the future, then you tend to buy it. You just can’t buy it at any price, then it may happen that you are buying it at a price which will not give you enough margin during the sell and you will end up with a lower profit or even loss. For this, a trigger point is decided which is the Stop. Then a closing point is decided which is known as Limit.
Once the price reaches the trigger point, then Stop gets activated and either BUY/SELL starts happening for the stock till the point where the limit is placed.
When to use Stop-Limit Order?
In Bulk trading, especially for Mutual Funds and Institutional Investors, the stock price tends to move with the order. Say a mutual fund is planning to sell its position on a particular stock. Usually, they hold huge positions and when they sell them, the price moves in the market, which makes the later trades at unfavorable prices.
To prevent trades happening at unfavorable prices, we put Stop-Limit order. It will stop the trade when price becomes unfavorable either in BUY or SELL.
Example of Stop-Limit Order
Alibaba Group Holdings is trading in NYSE at $200. Say an HNI is planning to buy 100,000 shares of Alibaba. The HNI thinks that the share price will increase, but he is not so sure about this. So he has planned to start buying the shares if it shows movement and reaches $205.
So for this, he will have to put a stop order at $205. Now it may happen that the share price after reaching $205, starts to grow tremendously and reaches $280. So it will be a loss for the HNI to buy the share at such a high price of $280.
To safeguard himself from buying at such unfavorable price, he will have to combine Stop Order with a Limit order, which will limit the buying price to a range, say he puts a limit order at $215. So the order will stop if share price crosses $215 and will again resume trading when the share price reaches $215 or below.
In case of highly volatile stocks, say you have put a Stop price and a limit price. It may happen that the Stop price will be triggered and due to high volatility it will cross the limit price too quickly, this, in turn, will leave you with partially filled order or with no fill order.
- Helps to execute order only at favorable prices
- Helps to break the trade and hence too much SELL/BUY pressure is avoided
- Price may move too quickly and order may not be fulfilled at all
- Favorable price may not return ever
A stop-limit order is very helpful if your prediction is correct. There are several scenarios where this order never gets triggered or fulfilled. So it requires precise judgment and prediction to place this order.
This has been a guide to what is Stop Limit Order. Here we discuss the features and example of a stock limit order, how does it work along with its risk and drawbacks. You can learn more about finance from the following articles –