Whether you're new to trading or looking to sharpen your skills, understanding order types is fundamental to executing your strategy effectively. Two of the most common and important order types are the limit order and the stop order. While they may sound similar, they serve very different purposes in the market.
This guide breaks down what each order type is, how they work, their advantages and risks, and when you should use one over the other.
What Is a Limit Order?
A limit order is an instruction you give to your broker to buy or sell a security at a specific price or a better one. It provides price protection, ensuring you never pay more than your set price when buying or receive less than your set price when selling.
How a Buy Limit Order Works
When you place a buy limit order, you are stating the maximum price you are willing to pay for a stock. The order will only be executed if the market price reaches your specified limit price or falls below it.
For example, if a stock is trading at $50 per share but you believe it’s overvalued, you could set a buy limit order at $45. Your broker will only purchase the stock if its price drops to $45 or lower.
How a Sell Limit Order Works
A sell limit order specifies the minimum price you are willing to accept for a stock you own. The order will only be filled if the market price rises to meet your limit price or exceeds it.
Imagine you own a stock currently trading at $75. If you want to sell your shares but only if the price reaches $80, you would place a sell limit order at $80. Your shares will not be sold until that target price is available in the market.
Advantages and Disadvantages of Limit Orders
The primary advantage of a limit order is control. You are guaranteed to get the price you want—or a better one—eliminating unpleasant surprises.
However, the major disadvantage is that the trade is not guaranteed to be executed. If the stock’s price never reaches your specified limit, your order will simply go unfilled. This is known as execution risk.
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What Is a Stop Order?
A stop order, often called a stop-loss order, becomes a market order once a specific "stop price" is triggered. Its primary purpose is to limit a loss or protect a profit on an existing position. Unlike a limit order, it does not guarantee a specific execution price.
How a Buy Stop Order Works
A buy stop order is set above the current market price. It is typically used to enter a trade once a stock shows momentum by breaking through a resistance level.
For instance, if a stock is trading at $90 and you believe it will continue to climb if it hits $95, you can place a buy stop order at $95. Once the stock reaches that price, your order converts to a market order and is filled at the next available price.
How a Sell Stop Order Works
A sell stop order is set below the current market price. It is most commonly used as a stop-loss to limit potential losses on a stock you own.
If you buy a stock at $100 per share and want to cap your potential loss, you could place a sell stop order at $90. If the stock price falls to $90, the order is triggered and becomes a market order, selling your shares at the prevailing market price.
Advantages and Disadvantages of Stop Orders
The key advantage of a stop order is that it is almost always executed once the stop price is hit, ensuring you can exit or enter a position automatically.
The disadvantage is the lack of price control. Because it becomes a market order, you could experience slippage—the difference between the expected price of a trade and the price at which the trade is actually executed. In a fast-moving market, the final execution price might be significantly worse than your stop price.
The Hybrid Approach: Stop-Limit Orders
A stop-limit order combines features of both order types to give traders more precision. It involves setting two prices: a stop price that activates the order and a limit price that restricts the execution price.
How a Stop-Limit Order Works
Once the stop price is triggered, the order becomes a limit order, which will only be executed at the limit price or better. This helps prevent the slippage associated with a standard stop order.
For example, you own a stock trading at $200. You want to sell if the price drops to $195, but you don’t want to sell for anything less than $193. You would set a stop price at $195 and a limit price at $193.
Risks of Stop-Limit Orders
The main risk with a stop-limit order is that it may not be filled at all. If the stock price gaps down—jumping from your stop price directly past your limit price—your order will be activated but will go unfilled because the market price never met your limit. This leaves you holding a position that may continue to decline in value.
Key Differences at a Glance
| Feature | Limit Order | Stop Order |
|---|---|---|
| Primary Purpose | Control execution price | Enter/exit at a specific price point |
| Price Guarantee | Yes | No |
| Execution Guarantee | No | Yes (but not at a specific price) |
| Best For | Getting a specific price | Ensuring an order is executed |
Practical Examples in Trading
Example 1: The Cautious Buyer with a Limit Order
You are interested in Company XYZ, which is volatile and currently trading at $30. You think it's a good buy at $25. Instead of constantly watching the chart, you place a buy limit order at $25. If the price drops to $25, your order is filled automatically. If it never drops that low, you avoid buying at a price you deem too high.
Example 2: The Protective Investor with a Stop Order
You bought shares of Company ABC at $50, and they have since risen to $80. You want to protect your profit from a sudden downturn. You set a sell stop order at $75. If the stock reverses and falls to $75, the order triggers and sells your shares at the market price, locking in most of your gains.
Frequently Asked Questions
What is the main risk of a limit order?
The main risk is that the order may not be executed. If the market price never reaches your specified limit price, your trade will not go through, and you might miss a potential opportunity.
When should I use a stop order instead of a limit order?
Use a stop order when your priority is ensuring the trade is executed, such as when you need to exit a position quickly to cap a loss. Use a limit order when your priority is achieving a specific price, and you are willing to risk the order not being filled.
Can a stop order guarantee I'll get the stop price?
No. A stop order guarantees that a market order will be placed once the stop price is hit, but it does not guarantee the execution price. The final fill price could be higher or lower than the stop price due to market volatility.
What is a stop-limit order best used for?
A stop-limit order is best used in less volatile markets where you want the activation feature of a stop order but also want to control the execution price to avoid significant slippage.
Is there a fee difference between these orders?
Brokers often charge higher fees for limit orders due to the additional effort required to execute them at a specific price, compared to simple market orders triggered by stops.
Can I cancel an order after it's placed?
Yes, you can typically cancel any pending order (limit, stop, or stop-limit) as long as it has not yet been triggered and executed.
Making the Right Choice for Your Strategy
Choosing between a limit order and a stop order depends entirely on your trading goals and risk tolerance.
- Use a Limit Order if price is your most important concern. It is ideal for disciplined investors who have a strict entry or exit point in mind and are not in a hurry to execute the trade.
- Use a Stop Order if execution is your priority. It is an essential tool for risk management, helping you to automatically cut losses or ride a breakout without needing to monitor the markets constantly.
Understanding these tools allows you to place orders with confidence, knowing you are effectively managing both your entry points and your risk. 👉 View real-time trading tools