Stop and Limit orders are conditional trades over a set time frame which combines the features of stop order as well as those of limit order. This tool is used to mitigate risk.
The stop limit order will be executed at a specific price or better price after the given stop price has been reached. Once this stop price is reached, the stop limit order becomes a limit order to buy or sell at the limit price or better price.
Such type of orders specifies how your broker is going to execute your trade orders.
A limit order is recorded and seen by the market, whereas the stop order cannot be seen until it is executed.
For example, if you want to buy an Rs. 100 stock at Rs. 90 per share, then your limit order can be seen and visible to the sellers and is executed when sellers are willing to meet your price. These orders enable traders to have prices control over the trade orders when they are to be executed. However, sometimes these orders are not guaranteed to be executed in a highly volatile market.
How stop & limit order works
A stop limit order requires a set of two prices.
- Stop price:- This specifies the target price for the trade.
- Limit price:- This price is the outside price beyond the target price of the trade.
A stop order is an order to buy or sell a security when its price moves past a particular point ensuring a high probability of achieving a predetermined entry or exit price. This limits the investor’s or loss or locking the profit. Once the price crosses the predefined price either on exit or entry, the stop order becomes a market order.
The limit order is the use of a predetermined price to buy or sell a security. For example, if the trader is looking a buy “ABC” stock but has a limit of Rs. 15/-, they will buy the “ABC” stock only at Rs. 15.00 or lower, Similarly, if the trader is looking to sell a share of “ABC” stock with Rs. 15/- limit, the trader will not sell any shares until the price is Rs. 15/- or higher.
A limit order gives a trader more control over the execution of price of a stock in the event they apprehend of using a market order during the period of high volatility.
There are various events when the limit orders can be used. Such as when stock is either rising or falling very quickly and a trader is fearful of getting an unfavorable trade from the market. Another instance may be that the trader may not be watching the stock and he has a specific price in his mind at which he is willing to buy or sell the stock. Limit orders can also be left open with an expiration date.
A stop order comes in a few different variations. They are based on a conditional price that is not yet available in the market when the order was placed. Once the ordered price is available, the order will be triggered and the broker will execute them differently.
For example, if you set up a stop order with a stop price of Rs. 100/-, it will be triggered only if a valid quotation of Rs. 100/- or better is met. A stop order will become a traditional market order once the stop price is met.
Features of stop and limit orders
A stop order is an order that becomes executable once the set price has been reached and executed at the current market price. A traditional stop order will be executed fully regardless of any change in the current market price as the trades are completed.
A limit order is one that is set a certain price. It is only executable at a limit price or an at more favorable price than the set limit price or at a more favorable price than the set limit price. If the trading actively causes the price unfavorable to the limit price, the activities related to the limit order will be ceased.
So by combining the two orders i.e. stop order and limit order, the investor holds the much precise control in executing the trade.
The stop order is filled at the market price, once the stop price is reached regardless of the price changes to an unfavorable position. This can lead to trades completed at less than desirable prices if the market adjusts quickly. By combining it with the feature of a limit order, the trading can be halted once the pricing becomes unfavorable, based on investor’s limit.