Stop Vs. Stop-Limit Order: How Do They Differ?

Stop-loss (sometimes also known as stop orders) and stop-limit orders are two common tools used by day traders to manage risk when dealing with assets of any kind – stocks, crypto, Forex, commodities, and many more. Both types of orders are useful to help protect profits or limit losses, but they have different advantages and disadvantages that should be considered when deciding which one is right for your trading strategy. 

In this article, we will compare stop loss vs stop limit orders, examine their advantages and disadvantages, and discuss when it might be best to use each.

Key Takeaways:

• Orders in trading can be divided into market, limit and stop orders.
• There are two types of stop orders: stop-loss and stop-limit. 
• Stop-loss orders are generally executed faster than stop-limit orders but have the potential to experience slippage, while stop-limit orders offer added flexibility as they allow investors to set a limit price but may take longer to execute. 
• Traders need to decide which type of order is best for their trading strategy depending on their goals and risk tolerance.

But first, we need to comprehend some basic concepts. 

Many Types of Orders

In the world of trading, an order is an instruction given by a trader or investor to their broker to buy or sell an asset.

Orders can be divided into two categories: 

• buy orders,
• sell orders.

Buy orders are instructions given by investors to purchase a specific asset, while sell orders are instructions provided by investors to sell a particular asset.

Today, the three most basic types of orders are used by traders: 

• market orders,
• limit orders,
• stop orders.

All of them have different characteristics, and each can be used in specific situations.

Market Orders

Market orders are used when it is desired to buy or sell a security at the latest market price. The order will be filled immediately, but no guarantee can be given as to whether it will be filled at the same price that was expected by the trader. 

To illustrate, if a trader wanted to trade currency at the market price, he or she would place a market order. The order would be filled immediately at the best available price for that moment. However, it is possible that the actual trade execution price may differ slightly from what was anticipated due to market fluctuations.

Limit Orders

A limit order, on the other hand, is filled only when the price of an asset reaches a certain threshold that has been pre-specified by the trader. This type of order provides more control over the price at which the trade is executed, but it has no guarantee of being filled since the price may never reach the specified level.

For instance, if an investor is interested in buying a cryptocurrency at $20 per token and places a limit order, the order will not be filled until the price of the token reaches that threshold. 

Stop Orders

Lastly, stop orders are a lot like limit orders in that they involve setting a price threshold – they are triggered when the price reaches a certain point, known as the “stop” price. After that, it automatically turns into a market order and then fills at the market price.

For example, if a trader wishes to buy shares of a stock currently trading at $100, they can set a stop order with the “stop” price set at $105. When the stock price reaches $105, the stop order will turn into a market order and fill at the best available price. This could be above or below the current price of $105, depending on market conditions.

How Do Stop Orders and Limit Orders Differ?

When comparing a stop order vs limit order, the main difference between the two is in how and when orders are filled. Stop orders become market orders and are filled at the current market price once they reach the specified “stop” price. This means the investor may not get the exact price they were hoping for, as it could be lower than the price they specified. 

On the other hand, with limit orders, the order is filled at the exact price (or better) that was set by the investor when it reaches or passes the threshold. This means that there is no concern about getting a worse price than expected. 

Also, when choosing, for instance, between buy limit vs buy stop orders for use in a particular situation, we must remember that there is less guarantee that the buy limit order will be even filled, as the price may never reach the specified level.

What Is a Stop-Loss Order?

A stop-loss order is an alternative name for regular stop orders, which we’ve discussed previously.

Stop-loss orders are used to automatically close out positions at a certain price or worse. This type of order is commonly used by traders to minimise losses (and hence the name) in case the market moves against them.

Traders often utilise stop-loss sell orders as a risk management strategy to safeguard their investments. These orders are typically placed when a trader is prepared to sell a particular asset at a price below the current market rate. This approach is adopted by traders who anticipate a potential unfavourable movement in the market, enabling them to mitigate potential losses and protect their capital.

On the other hand, with a stop-loss buy order, traders can purchase a currency or a stock above the price that they shorted it at.

What Is a Stop-Limit Order?

A stop limit order is another type of stop order that offers the advantages of both stop orders and limit orders. With this type of order, traders set two different price points: a ​stop price​ (as in the case of regular stop orders) and a ​limit price​.

The trade is initiated when the trade price of the asset reaches or surpasses the stop price. However, when the trade is executed, it will be done at or better than the limit price set in the order.

Let’s take an example: imagine a trader who wants to buy shares of a company when their price goes above $25. In this case, the trader could use a stop-limit order with a stop price of $25 and a limit price of $26. This way, the order will be triggered as soon as the market price reaches or exceeds $25, ensuring that the order is executed at a maximum price of $26.

On the other hand, if the trader chooses to use a stop-loss order with a stop price of $25, their order would be triggered at a market price as soon as the stock’s price reaches about $25.

Thus, stop-limit orders can be used to ensure that traders get an acceptable price for their trades and don’t miss out on profits because the market or price moves up too quickly. It also allows traders to control their risk more precisely as they know exactly at what price the trade will be executed.

Limits and Stop Limits

When comparing limit vs stop limit, it is important to remember that a limit order is one of the building blocks of a stop-limit order. While both types of orders involve setting a price threshold, limit orders are only filled when the price of an asset reaches or passes the first specified price threshold. On the other hand, stop-limit orders are filled only when the price of an asset reaches the stop price – and then the limit price will be activated.

Stop-Loss vs. Stop-Limit: Advantages and Disadvantages

So, now that we understand what each type of order is, let’s take a look at the advantages and disadvantages of using stop vs stop limit orders. 

Stop orders have one clear advantage – they are less complicated to set up. As investors don’t have to be concerned with setting precise entry and exit points, they can spend more time focusing on their overall trading strategy. 

However, while both types of orders are designed to limit possible losses, it is worth noting that only a stop-limit order provides the added advantage of guaranteeing execution at a specific price. This additional level of precision allows traders to have greater control over their investment outcomes, ensuring optimal risk management in volatile market conditions.

In comparison, stop orders have the potential to be triggered at prices that are significantly worse than expected, resulting in greater losses. This is due to the fact that unlike stop-limit orders, they lack a price guarantee and can therefore only execute within a certain range of market prices. 

Stop-Loss vs. Stop-Limit: What to Choose?

At the end of the day, traders need to decide which type of stop order is best for their trading strategy. Whether to use a stop-loss or stop-limit order depends on the trader’s certain goals and risk tolerance, as well as the volatility of the market they are trading in. 

For instance, if an investor is willing to accept some price uncertainty for the sake of speed, then a stop-loss order may be more suitable. On the other hand, if precision and control are more important, then a stop-limit order might be the better choice. 

Stop-loss order can be a useful tool for hedging against short-term volatility. By setting a stop-loss one, traders are able to limit their risk in the event of sudden unexpected market movements. This is especially important when trading in volatile markets such as cryptocurrencies or commodities.

At the same time, stop-limit orders can also provide investors with added flexibility. If the specified limit price is missed, the investor has the option to cancel or modify the order. This allows investors to reconsider their position and make adjustments depending on market conditions.

Conclusion

For any investor or trader, it is important to first understand the basics of how financial markets operate before actually entering into them. Being familiar with the different types of stop orders and how they work can give traders a better chance of success when trading on margin or in volatile markets.

By taking the time to carefully weigh up the advantages and disadvantages of stop-loss vs stop-limit orders, traders can be better equipped to make informed and profitable decisions when entering into markets.

No matter how advanced one’s knowledge and understanding of the markets may be, one needs to remember that trading in any market carries certain risks. Before entering into a trade, investors should make sure they are aware of all the risks and rewards involved.

FAQs

How can I use a stop order to limit my risks?

Stop orders can be used to limit losses in the event of sudden market movements. By setting a stop order, you can ensure that your position is automatically closed upon reaching the target price or worse. 

What type of order should I use for my trading strategy?

The type of order best for a particular trading strategy depends on the trader’s goals and risk tolerance, as well as the volatility of the market they are trading in. For instance, if an investor is willing to accept some price uncertainty for the sake of speed, then a stop-loss order may be more suitable. On the other hand, if precision and control are more important, then a stop-limit order might be the better choice.

What is the best way to manage risk in the cryptocurrency market? 

Cryptocurrency markets can be volatile, so protect yourself with stop orders to limit losses in sudden market movements. Additionally, diversify your portfolio across assets and markets, avoiding overexposure. Monitor and adjust trades according to market conditions. Finally, practice risk management – stick to what you understand and never invest more than you can afford to.

What is a trailing stop order? 

A trailing stop order is an automated order that follows the price of a security. This means that when the stock moves in your favour, the stop will move accordingly and protect profits up to the level specified by you. On the other hand, if the stock moves against you, it will close out your position at your specified stop price. This type of order can be useful for long-term investors who want to limit their downside risk. 

Can I cancel or modify a stop-limit order?

Indeed, you may be able to cancel or alter a stop-limit order in some circumstances. But once the specified stop rate is attained and your transaction is initiated, it turns into a limit order that is then subject to the rules of that market. 

What types of trading strategies are best suited for stop orders? 

Stop orders can be used in various trading strategies, such as trend following, range trading and scalp trading. In trend following strategies, traders use stops to capture profits and limit losses. In range trading strategies, traders use stop orders to buy or sell when prices break outside of predetermined support or resistance levels. Finally, in scalp trading strategies, stop orders are used to quickly enter and exit short-term trades with the goal of taking small profits from price fluctuations. 

Do all markets allow stop orders? 

Stop orders are an incredibly useful tool in trading, yet not all exchanges offer them. Therefore, it is vital to confirm with your broker or exchange that they allow for this type of order within the desired market. Additionally, certain markets may have limitations as to when/how stop orders can be used, so always be certain to check and understand the rules and regulations of a particular exchange beforehand. Taking the time to review these terms and conditions can save you from costly mistakes or unanticipated losses.