What’s the difference between a stop and a limit order? What about a stop-limit, trailing stop or market order? It’s easy to get confused between these common order types – often the names get tossed around, as if everyone was born knowing what these terms mean. Here’s a quick primer.
Let’s start with the order type pretty much everyone knows: the market order. A market order is an order to buy or sell a security as soon as possible for the best available price. Speed and immediacy are the main goals. The advantages to using this type of order include guaranteed execution and a fill as soon as possible. The price of the execution is the secondary goal and is not determined.
The disadvantages include no control on price and the price received may vary greatly from the recent quote you observed, especially if the security is volatile or illiquid.
On to limit orders. Limit orders allow you to buy or sell a security at a specific price (or better – that’s lower if you’re buying and higher when you’re selling). Control over price is the main goal. Speed of execution may be important, but is secondary to price. The pros include deciding the price you will accept in advance and a guaranteed price IF your order is filled.
As you’d expect, there are cons, too. There is no control over whether the order will ever be filled, and as such, the market may “move away” from your limit price. This means the current trading price may become worse than the limit price you wanted, causing you to consider changing your price for the worse or waiting to see if the market comes back to your original limit price. There are ways to reduce these cons, but these are the main points about limit orders.
Both market and limit orders have speed or immediacy as part of the objective. On the other hand, stop orders remove this factor, as these orders are about “wait and see.”
Stop orders are used when you want to buy when the current price is higher OR you want to sell when the current price is lower, but NOT RIGHT NOW. The upside is you may place orders under special conditions without watching the market in real time. Once your condition is met or “triggered,” the stop order becomes a market order and is filled as soon as possible. This can be useful when planning to exit a trade to minimize losses.
On the downside, there is no control on price once the stop order is triggered and these orders may be particularly sensitive to price gaps. Gaps can be painful when using this order to hold losses to a certain amount – there is no guarantee that your order will be filled at the price you think you might get. Typically, exiting is something wanted quickly after a threshold is met, which fits the purpose of a stop order.
A gap is a large change in price between yesterday’s close and the next day’s open. It may also occur intraday, with a large change in price between two last sales (intraday). What’s a large change in price? That varies, however a rule of thumb can be defined as a percentage move relative to price of stock. An eyeball amount might start at 25 cents but can be up to several dollars or more.
If an order with these characteristics (buy when the price is higher OR sell when the price is lower) is submitted without the “stop,” the order would be filled immediately, as the “or better” feature of limit orders would come into play.
Here’s an example of a stop order in action. XYZ stock is trading for 52. You own it and have unrealized profits. You think it can go higher, but you want to protect your gains if the stock trades lower.
You enter a sell-stop for XYZ stock at 50. Your order is dormant right now because the stock is higher. Once the market has traded at your specified stop price (50) or lower, your order gets activated and becomes a market order.
So, imagine the following trades happen:
52
51.50
51
50.50
49.90
49.50
At 49.90 your sell-stop order gets activated because this is lower than your sell-stop price of 50. (This is called "trading through" your stop price.) It instantly becomes a market order. Your market order is now entitled to be filled at the next available price, whatever price that may be. In this case, it is 49.50; however it could be higher or lower than that.
Stop-limit orders start out life as a stop order, just like the example above, but when the stop price is activated, they turn into a limit order, not a market order.
The last main order type, trailing stops, are different: you specify a "trail" amount when entering them. Say you own a stock, but you want some protection on the downside. You can set a trailing stop order at one point (one dollar) below the current marker price of 50. As the stock price climbs to 52, then to 55, you'll participate in the rally as a stock owner. Your trailing stop will also climb (in 15 minute intervals), staying one point below the current market price. So if your stock rises to 55, your trailing stop would be set at 54. If the stock then starts to fall, trading at 54, your stop order will be triggered, becoming a sell market order.
This order allows you to participate in the four-point move higher, while offering some protection to the downside. Keep in mind: trailing stops have risks in addition to the ones outlined above for regular stop orders. For more information, please review the full terms and disclosures when using Advanced Orders. Trailing stops may also be set with a percentage amount, instead of a dollar amount.
If you’d like more examples or additional explanation about types of orders, here are two great webinar archives to meet those needs. Types of Orders covers the basics in detail. Advanced orders will be covered as an ongoing series. Trailing Stops was the first one of these. The next one will be on Contingent Orders. This live session will be held on June 25. Be sure to register.
Thanks to TK Network Member Alex1988 for the great question!
Regards,
--Nicole Wachs
Director of Education
All-Star Commentator
Nicole’s previous blog posts: Turning rookie luck into a plan and Jeff Clark / Growth Stock Wire joins All-Stars
Advanced orders are placed at TradeKing on a Not Held basis. When the conditions are met they are automatically released to the market as open orders. Certain advanced orders may not be eligible for execution when the condition is met (for example: you do not have enough buying power in your account). You solely are responsible for managing your orders to avoid errors, and the costs associated with the resolution. An advanced order can be held indefinitely until you decide to cancel it. Please note that advanced orders are particularly exposed to the risks derived from system malfunction and disruptions. Read a more descriptive disclosure about Advanced Orders.
Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Community, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs.
