Stop-Limit Order: What It Is and Why Investors Use It

What Is a Stop-Limit Order?

A stop-limit order is a conditional trade over a set time frame that combines the features of stop with those of a limit order and is used to mitigate risk. It is related to other order types, including limit orders (an order to either buy or sell a specified number of shares at a given price or better) and stop-on-quote orders (an order to either buy or sell a security after its price has surpassed a specified point).

Key Takeaways

Stop-limit orders are a conditional trade that combine the features of a stop loss with those of a limit order to mitigate risk.
Stop-limit orders enable traders to have precise control over when the order should be filled, but they are not guaranteed to be executed.
The stop price dictates the price whether the order is triggered, then the limit price dictates the price at which the order is filled.
Stop-limit orders offer risk management, automation, and flexibility in trading, though they do not protect against price gaps and are slightly more complex to set.
Traders often use stop-limit orders to lock in profits or limit downside losses.

How Stop-Limit Orders Work

The primary benefit of a stop-limit order is that the trader has precise control over when the order should be filled. The downside, as with all limit orders, is that the trade is not guaranteed to be executed if the stock/commodity does not reach the stop price during the specified time period.

A stop-limit order requires the setting of two price points: the stop price and the limit price. First, set the stop price which is the price at which you want the trade to be triggered. If the price of the security reaches or falls below the stop price, the trade will be triggered. Once these have been set

Then, set the limit price. The limit price is the price at which you want to buy or sell the security. This price is used to limit the maximum price you will pay or the minimum price you will receive for the trade. A time frame must also be set, during which the stop-limit order is considered executable.

The stop-limit order will be executed at a specified price, or better, after a given stop price has been reached. Once the stop price is reached, the stop-limit order becomes a limit order to buy or sell at the limit price or better. This type of order is an available option with nearly every online broker.

It's important to note that stop-limit orders do not guarantee that your trade will be executed. If the price of the security drops quickly or there is a gap in trading, the order may not be filled at the desired limit price or at all. This may result in missed opportunities of profit should the appropriate prices not be targeted.

Features of Stop and Limit Orders

A stop order is an order that becomes executable once a set price has been reached and is then filled at the current market price. A traditional stop order will be filled in its entirety, regardless of any changes in the current market price as the trades are completed.

A limit order is one that is set at a certain price. It is only executable at times when the trade can be performed at the limit price or at a price that is considered more favorable than the limit price. If trading activity causes the price to become unfavorable regarding the limit price, then the activity related to the order will be ceased. By combining the two orders, the investor has much greater precision in executing the trade.

A stop order is filled at the market price after the stop price has been hit, regardless of whether the price changes to an unfavorable position. This can lead to trades being completed at less than desirable prices should the market adjust quickly. Combining the stop order with the features of a limit order ensures that the order will not get filled once the pricing becomes unfavorable, based on the investor’s limit. Thus, in a stop-limit order, after the stop price is triggered, the limit order takes effect to ensure that the order is not completed unless the price is at or better than the limit price that the investor has specified.

Stop-limit orders are commonly free to enter into; ensure you understand your broker's fee structure before setting orders and unexpectedly being assessed order fees.

Advantages and Disadvantages of Stop-Limit Orders

Pros of Stop-Limit Orders

There are several reasons why traders may rely heavily on stop-limit orders, as there are a handful of strong benefits of the order.

Price Control: With a stop-limit order, you can control the price at which you enter or exit a trade. This means that you can set a limit price that is higher or lower than the stop price, depending on whether you are buying or selling. This gives investors greater control over the execution price and helps traders avoid getting filled at a price that is unfavorable.
Risk Management: Stop-limit orders are an effective way to manage risk. By setting a stop price, investors can limit their losses if the market moves against them. By setting a limit price, you can ensure that you don't get filled at a price that is too high or too low. This allows investors to control their risk and minimize their losses.
Automation: Once you place a stop-limit order, it will automatically be executed when the stop price is reached. This means that you don't have to monitor the market constantly and can let the order execute on its own. This can be especially useful for traders who cannot monitor the market or want a more passive style of trading.

Flexibility: Stop-limit orders can be used in a variety of trading strategies including day trading, swing trading, and position trading. They can be used to enter or exit a trade, and they can be used for both long and short positions. This flexibility makes stop-limit orders a versatile tool for traders regardless of the style of trading that investor wants to adopt.

Cons of Stop-Limit Orders

Though stop-limit orders have a suite of strong uses, there are also drawbacks to the product.

Uncertainty: While a stop-limit order can help you control the price at which you enter or exit a trade, there is no guarantee that the order will be filled. If the market moves quickly and the price never reaches your limit price, your order may not be executed at all. This can be especially problematic in fast-moving markets where prices can fluctuate rapidly.
Price Gaps: Another potential disadvantage of stop-limit orders is that they may not protect you against price gaps. A price gap occurs when the price of a security jumps from one level to another without any trades occurring in between. If this happens and your limit price is not met, you may end up getting filled at a price that is much worse than you anticipated.
Psychological Pressure: Stop-limit orders can also create psychological pressure on traders. When a stop-loss is triggered, it can be tempting to hold on to the position in the hope that the market will reverse and the price will come back up. This can lead to indecision and emotional trading, which can be harmful and detrimental to a broader trading strategy.

Complexity: Stop-limit orders can be more complex to set up and execute than other types of orders. Compared to market orders or limit orders, there are more factors, considerations, and inputs needed when setting the order. Traders need to be familiar with the process of setting a stop price and a limit price, and they need to understand how these prices interact with the market.

Pros

Allows investors to largely control the price in which they enter or exit a trade
Allows investors to ensure an order doesn't get filled at too high or low of a price, mitigating some trading risk
May allows for a more passive, automated style of trading
May be used in a variety of trading situations

Cons

May not execute if the price never meets the limit price
Does not offer protection against price gaps, potentially resulting in worse order fills than expected
May create pressure to hold onto positions
Are more complex to set up compared to other types of orders

Stop-Limit Order vs. Stop-Loss Order

Both a stop-limit order and a stop-loss order are useful for traders trying to manage risk. There are key difference between the two that change the situation where each may be best. First, a stop-loss order becomes a market order when the price of the security hits or falls below the stop price. This means that the order will be executed at the best available market price which may be different from the stop price. In contrast, a stop-limit order becomes a limit order when the stop price is reached, and will only be executed at the limit price or better. Therefore, the two have different execution points.

There is also pricing protection differences. A stop-loss order does not offer any price protection beyond the stop price. This means that if the market is experiencing rapid price movements or gaps, the trade may be executed at a price below the stop price. On the other hand, a stop-limit order offers price protection as it specifies a limit price at which the trader is willing to buy or sell. This allows a trader to have greater control over the execution price.

In addition, a stop-loss order is guaranteed to be executed once the stop price is triggered, but the execution price may not be guaranteed. In contrast, a stop-limit order is not guaranteed to be executed, as the order will only be filled if the limit price is met. Therefore, a stop-loss order is better should a trader want to ensure a trade is executed regardless of price.

Example of a Stop-Limit Order

For example, assume that Apple Inc. (AAPL) is trading at $155 and that an investor wants to buy the stock once it begins to show some serious upward momentum. The investor has put in a stop-limit order to buy with the stop price at $160 and the limit price at $165. If the price of AAPL moves above the $160 stop price, then the order is activated and turns into a limit order. As long as the order can be filled under $165, which is the limit price, the trade will be filled. If the stock gaps above $165, then the order will not be filled.

Buy stop-limit orders are placed above the market price at the time of the order, while sell stop-limit orders are placed below the market price.

What Is the Difference Between a Stop-Loss Order and A Stop-Limit Order?

A stop-loss order assures execution, while a stop-limit order ensures a fill at the desired price. The decision regarding which type of order to use depends on a number of factors.

A stop-loss order will get triggered at the market price once the stop-loss level has been breached. An investor with a long position in a security whose price is plunging swiftly may find that the price at which the stop-loss order got filled is well below the level at which the stop-loss was set. This can be a major risk when a stock gaps down—say, after an earnings report—for a long position; conversely, a gap up can be a risk for a short position.

A stop-limit order combines the features of a stop-loss order and a limit order. The investor specifies the limit price, thus ensuring that the stop-limit order will only be filled at the limit price or better. However, as with any limit order, the risk here is that the order may not get filled at all, leaving the investor stuck with a money-losing position.

Do Stop-Limit Orders Work After Hours?

Stop-loss orders will only be triggered during standard market hours, which is generally 9:30 a.m. to 4 p.m. EST. They will not get executed during extended-hours sessions or when the market is closed for weekends and holidays.

What Is an Example of a Stop-Limit Order Used for a Short Position?

A short position would necessitate a buy-stop limit order to cap losses. For example, if a trader has a short position in stock ABC at $50 and would like to cap losses at 20% to 25%, they can enter a stop-limit order to buy at a price of $60 and a limit price of $62.50. If the stock trades at a price of $60 to $62.50, then the stop-limit order will be executed, capping the trader’s loss on the short position in the desired 20%–25% range. However, if the stock gaps up—say, to $65—then the stop-limit order will not be executed and the short position will remain open.

How Long Do Stop-Limit Orders Last?

Stop-limit orders can be set as either day orders—in which case they would expire at the end of the current market session—or good-’til-canceled (GTC) orders, which carry over to future trading sessions. Different trading platforms and brokerages have varying expiries for GTC orders, so check the time period when your GTC order will be valid.

The Bottom Line

A stop-limit order refers to a conditional order type used by investors and traders to mitigate risk. The order, which combines the features of both a stop and limit order, provides more precision over the desired execution price, helping to lock in profits and limit losses. Investors set a stop-limit order by placing the stop price where they want the order to trigger and a limit price where they would like a trade execution. If the security reaches the specified trigger price, the limit order activates and executes if the price is at or better than the price specified by the investor. Most online brokers offer stop-limit orders with a day-only or GTC expiry.