If the pandemic and lockdowns are still fresh in your mind, then you might remember the popularity that food delivery apps like DoorDash and Uber Eats had. A food order could be executed immediately with just a few taps on a smartphone. But one of the biggest perks of these apps is customizing when you want your order delivered. You can have it delivered immediately, or schedule it for a specific time in the future.
Scheduling an order is a good way to describe how a limit order works when buying stocks. Except unlike a dinner order, you aren’t concerned about a specific time with a stock – you want it at a specific price. Limit orders allow you to execute trades without hovering over your screen non-stop, but they aren’t the only order type that works on a specific schedule. Stop orders are also scheduled orders that allow traders to pick an execution price. However, they operate a little differently than limit orders.
Limit Orders: Definition
A limit order is a type of order that instructs your broker to buy or sell a certain stock at a maximum or minimum price. Unlike market orders which are executed immediately, limit orders won’t be executed until the specific ‘limit price’ is reached. If the stock you’re attempting to buy or sell does not reach the limit price, the order will not be executed.
Buy limit orders will only be executed at the maximum price or lower, while sell limit orders will only be executed at the minimum price or higher. Let’s say you want to buy XYZ stock at $15 per share, but the current price is $17 and you think that’s a little steep. In this scenario, you’d set a limit buy order for $15 so that the shares would only be purchased if the price drops to $15. A limit sell order works the same way but in reverse. If you own XYZ at $15 per share and want to take profits at $20, you’d enter a limit sell order at $20 which would lock in your profits at $20 or higher.
Limit orders have some limitations (no pun intended). You can’t guarantee your order will be executed, or even that it will get completely filled should your limit price be reached. Additionally, you must choose whether you want your order to be active for just a single trading session or to remain open until it’s canceled.
Stop Orders: Definition
Stop orders work in reverse of limit orders. Like a limit order, you don’t enter a stop order and have it executed right away. You’ll need to enter a stop price, which sounds very similar to a limit price. However, stop orders are used to prevent losses. A sell stop order will protect your investment by executing when the shares in question drop below a specific price.
A buy-stop order may seem counterintuitive, but it’s actually a useful tool for capturing the upside of a breakout. A buy stop order will only execute if a stock rises to a specific price. Why would we want to buy a stock at a higher price than it is right now? In technical trading, a breakout is often characterized by a rapid increase in price. A buy stop order allows traders to purchase shares during this rapid increase and ‘ride the wave’ of the breakout.
One of the most common examples of a stop order is the stop loss. A stop loss is a sell stop order that’s set to lock in profits should a winning stock suffer a decline. Let’s say you’ve owned XYZ shares since $15 and now the stock sits all the way at $35. You’ve more than doubled your original investment and now want to protect your gains. So you enter a stop-loss order at $30, which will sell your stock should the shares drop below $30.
Stop-Limit Orders
Stop limit orders are a little different than the previous two examples in that they combine the features of both types. A stop-limit order requires the entering of two separate price points: the limit price AND the stop price.
What’s the difference here between the limit and the stop prices? The answer is that stop-limit orders are actually a combination of two individual orders. The stop price is when the first part of the order is executed, but unlike a limit order, the stock won’t actually be bought or sold immediately when the stop price hits.
When the stop price is reached, a limit order is triggered. This prevents slippage in execution price since the stop price triggers another specific type of order, not a market order with an immediate buy. Stop-limit orders give traders precise entry and exit points when trading, even if they can’t personally monitor the stock during the order execution.
Here’s a final example with XYZ stock. Let’s say the company has become a juggernaut and now trades at $100 per share. You’re a new investor looking for an entry point in the stock, so you decide to utilize a stop-limit order. The stock is volatile, so you enter a stop price of $105 and a limit price of $110. Once the shares reach $105, the stop order will execute and trigger the limit order. The limit order will fill as long as the shares stay below $110. If you want 100 shares, the order will begin filling at $105 but will stop if the stock quickly shoots over $110. If only 70 shares can be acquired below the $110 limit price, then that’s all you’ll have in your account after the trade is executed. Remember, stop-limit orders guarantee price precision, not complete order fills.
Final Thoughts
If you’re a day trader or swing trader looking to maximize your profits, these different types of orders are definitely a must to know. Limit, stop, and stop-limit orders are important to ensuring that every dollar traded is done so in the best possible way.
Limit orders enable traders to take profits at pre-specified points and avoid purchasing overpriced shares. A stop order can be effective in limiting losses on an open position or capturing the upside of a stock that begins a long-awaited breakout. And finally, a stop-limit order can be used to get precise entry and exit points on a stock, but you must be wary of partial fills.
All of these order types can be used for different types of trades in all kinds of market conditions, but be sure to understand how they work and the drawbacks of each type. You don’t want to get mixed up and enter a stop order when you really wanted a stop-limit order. Be sure to double-check the structure of your order before hitting the submit button on your brokerage app.