What is a Stop-Limit Order?

Stop-Limit Order is a combination of Stop and Limit order, which helps 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.

Features

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 priceMarket PriceMarket price refers to the current price prevailing in the market at which goods, services, or assets are purchased or sold. The price point at which the supply of a commodity matches its demand in the market becomes its market price.read more, or else it will be triggered immediately after placement.Limit:- Limit means range; will indicate the starting point of the trade, and limit will indicate the closing point of the trade.

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How does it Work?

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 can’t buy it at any price; then, it may happen that you are buying it at a price that will not give you enough margin during the sale, 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 a Limit. Two prices are provided for Stop-Limit Order.

Once the price reaches the trigger point, Stop gets activated, and either BUY/SELL starts happening for the stock to the point where the limit is placed.

When to use Stop-Limit Order?

In Bulk trading, especially for Mutual FundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more and Institutional InvestorsInstitutional InvestorsInstitutional investors are entities that pool money from a variety of investors and individuals to create a large sum that is then handed to investment managers who invest it in a variety of assets, shares, and securities. Banks, NBFCs, mutual funds, pension funds, and hedge funds are all examples.read more, the stock price tends to move with the order. Say a mutual fund plans to sell its position on a particular stock. Usually, they hold huge positions, and when they sell them, the price moves in the market, making the later trades at unfavorable prices.

To prevent trades happening at unfavorable prices, we put a Stop-Limit order. It will stop the trade when the price becomes unfavorable, either BUY or SELL.

Example of Stop-Limit Order

Alibaba Group Holdings is trading on the NYSE at $200. Say an HNI is planning to buy 100,000 shares of Alibaba. The HNI thinks the share price will increase, but he is unsure about this. So he has planned to start buying the shares if it shows movement and reaches $205.

The share price after reaching $205 may start to grow tremendously and reach $280. So it will be a loss for the HNI to buy the share at such a high price of $280. So for this, he will have to put a stop order at $205.

To safeguard himself from buying at such an unfavorable price, he will have to combine Stop Order with a Limit order, limiting the buying price to a range, say he puts a limit order at $215. So the order will stop if the share price crosses $215 and will again resume trading when the share price reaches $215 or below.

Risk

In the 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 a partially filled order or with no fill order.

Benefits

  • Helps to execute orders only at favorable pricesIt helps break the trade, and hence too much SELL/BUY pressure is avoided.

Drawbacks

  • Price may move too quickly, and order may not be fulfilled at allFavorable price may not return ever

Conclusion

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 examples of a stock limit order, its risks and drawbacks, and how it works. You can learn more about finance from the following articles –

  • What is Short Selling?Position TradingAlgorithmic TradingPre-Market Trading