How Limit and Stop Orders Work
A limit order is an instruction to the broker to trade a certain number shares at a specific price or better. For example, for an investor looking to buy a stock, a limit order at $50 means Buy this stock as soon as the price reaches $50 or lower. The investor would place such a limit order at a time when the stock is trading above $50. For someone wanting to sell, a limit order sets the floor price. So a limit order at $50 would be placed when the stock is trading at lower than $50, and the instruction to the broker is Sell this stock when the price reaches $50 or more. Limit orders are executed automatically as soon as there is an opportunity to trade at the limit price or better. This frees the investor from monitoring prices and allows the investor to lock in profits. The trade will only execute at the set price or better.
A stop order, on the other hand, is used to limit losses. A stop order is an instruction to trade shares if the price gets “worse” than a specific price, known as the stop price.For example, a stop order at $50 placed by the owner of a stock currently trading at $53 means Sell this stock at the market price if the stock price hits $50. Conversely, someone looking to buy the same stock may be waiting for the right opportunity (a price dip) but may want to place a stop order to buy at $58. This would limit the downside by putting a ceiling on the price she pays to acquire the shares.
In a regular stop order, once the set price is reached, the order is executed at the market price. A stop-limit order provides the option to set a stop price and a limit price. Once the stop price is reached, the order will not be executed until the limit price is reached. Here’s an example that illustrates how the various trading options — market, limit, stop and stop-limit orders — work for buying and selling a stock priced at $30.
Limit orders guarantee a trade at a particular price.
Stop orders can be used to limit losses. They can also be used to guarantee profits, by ensuring that a stock is sold before it falls below purchasing price.
Stop-limit orders allow the investor to control the price at which an order is executed. The stop price and the limit price do not have to be the same.
Brokers may charge a high commission fee for limit orders. They also may never be executed if the limit price is not reached.
When a stop order is triggered, the stock is sold at the best possible price, which may be lower than the price specified by the stop order, as the trade is not instantaneous. This risk can be avoided by placing a stop-limit order, but that may prevent the order from being executed at all. Stop orders can also be triggered by a short-term fluctuation in stock price. Brokerage firms, like E*TRADE and Scottrade, have different standards for determining when a stop price has been reached, including last-sale prices or quotation prices.
As already mentioned, stop-limit orders may not be executed if the stock’s price moves away from the specified limit price. They can also be activated by short-term market fluctuations.
- Limit Orders – SEC.gov
- Trading Basics – SEC.gov