What is a Stop-Limit Order?

The stock market is often considered a synonym of volatility. Thus, trading with utmost caution is a necessity to avoid losses. To avoid mistakes while trading, a trader can place multiple types of trade orders based on the objective of the trading. Market order, stop-loss order, limit-order, and stop-limit order are commonly used trade orders. Each of these trade orders comes with different features, which can be executed by looking at the market scenario and the end goal of the traders.

A stop-limit order helps the trader to mitigate the risk. It gives them control over their price points. A stop-limit order is useful when there is a range of minimum and maximum prices at which a trader is ready to buy or sell the stock.

What is the stop-limit order?

A stop-limit order is a combination of two different types of trade orders, namely, stop order and limit order. A stop order is used to buy or sell financial security after its price surpasses the stop price. The stop price is decided by the investor. Once the stop order is activated, the trade is executed at the current best available price in the market, and not necessarily at the stop price. A limit order allows an investor to buy or sell a security at a pre-specified price or at a price better than that.

A stop-Limit order is the one in which the trade is executed when the security price surpasses the stop price, but at a limit, the price specified by the investor or better than the limit. Investors and traders can use stop-limit orders to lock in an expected profit or mitigate the risk of more loss than expected. A stop-limit order ensures that the trade gets executed only when investors get the price they set. Though, unlike stop order, there is no guarantee of trade execution. Trade will not be executed if the security price moves away from the pre-defined limit price.

Stop-Limit order can be used for various financial assets such as stocks, commodities, bond, and foreign exchange. Investors/traders can consider the time duration of investment, stock trends, market volatility, and other factors to decide on the stop and limit price. This type of trade order is more often used by those investors who do not/cannot constantly monitor the market.

Stop-Limit orders are triggered only during standard market hours. Events apart from standard market hours, such as extended time, pre-market and post-market hours, market holidays and stock halt will not trigger a stop-limit order.

Stop-Limit orders are mainly of two types: 1. Buy stop-limit order and 2. Sell stop-limit order.

Example of a buy stop-limit order

You can use buy stop-limit orders if you are willing to buy security, not above a particular price. Here, you can set stop and limit prices higher than the current market price, the limit price being the highest price investors are willing to pay for security. If the stock price goes above the limit price, the trade will not be executed.

For example, Priyansh wants to buy a stock of company XYZ Limited which is currently trading at Rs. 550. Since the company's recently announced quarter result showed revenue and profit growth, the share price is rising. He is willing to buy the stock when it hits Rs. 570, maximum at Rs. 580, but not more than that. Here, he can put a Buy stop-limit order by setting the stop price at Rs. 570 and limit price at Rs. 580. The order will be activated once the price surpasses Rs. 570. Though, the trade will not be executed if the stock crosses Rs. 580.

Example of a sell stop-limit order

Sell stop-limit order can be used when you are not ready to sell security below a certain price. You can set the stop and limit prices lower than the current market price, the limit price being the lowest price investor is ready to sell a security. If the stock price goes below the limit price, the trade will not be executed.

For Example, Kriya wants to sell a stock of ABC Limited, which is trading at Rs. 275. As the negative news about the company surrounded the market, the price started to decline. She is willing to sell the stock when it hits Rs. 265 but not below Rs. 250. Here, she can put a Sell stop-limit order by setting the stop price at Rs. 265 and limit price at Rs. 250. The order will be activated once the price goes below Rs.265. Though, the trade will not be executed if the stock crosses the limit of Rs. 250.

Traders can set stop-limit orders as ‘Day Order’ or ‘Good till Canceled (GTC) Order’. For example, if Priyansh sets the buy stop-limit order as a day order, the order will expire either when it is filled, or at the end of the day if the limit price is not triggered during the market hours of the respective day. However, if Kriya sets the sell stop-limit order as the good till cancelled order, the order will expire when it is executed or she cancels it. The maximum expiry time for GTC orders differs among different trading platforms.

How do stop-limit orders Work?

When placing a stop-limit order, an investor is required to determine two things, stop price and limit price. Though, the investor cannot set the same amount as the stop price and limit price.

When buying security, investors shall set a higher-stop and limit price than the current market price. In the case of selling, investors set stop and limit prices lower than market price. Further, they need to define the period for which they want the order to be valid i.e. Day or GTC.

Once the investor puts the stop-limit order, the order is sent to the respective stock exchange and registered on the order book. If the given stop and limit or better price is triggered, the trade will be executed.

In case the given stop and limit price is not triggered, the order will expire at the end of the day or get cancelled.

Features of Stop and Limit Orders?

The key feature of stop order is that the trade is executed at market price when the price reaches the stop price. A limit order is characterized by trade execution at a fixed limit price set by an investor or a better price. Investors place this order when the stock price is the main concern.

A stop-limit order facilitates an investor with minimal risks by combining key features of stop and limit orders. It is a stop order at first, and when the price reaches the stop price level the same order becomes a limit order. The stop-limit order is characterized by risk mitigation, price certainty, and unguaranteed trade execution.

Conclusion

To sum up, a stop-limit order is a way to enter and exit a position in the stock market at a price an investor is willing to pay or accept. It guarantees that trade will be executed only if a certain price limit is reached. Thus, it prevents high losses. Though, this trade order is not risk-free.

One of the risks is that investors would not be able to get a trade if the security price crosses the limit level without touching it. There is a chance for partial fulfilment of an order, too. Now, partial fulfilment leads to multiple trades resulting in higher brokerage payments.

Whether to use a stop-limit order for trade depends on the investor's main objective of trade.