How Stop Limit Orders Work

Some investors also use buy limit orders, automatically buying when the price is reached.
Some investors also use buy limit orders, automatically buying when the price is reached. (Image: Jupiterimages/Goodshoot/Getty Images)

When you buy a stock, you hope that the price will rise and you will be able to sell it for a profit at some point in the future. Unfortunately, prices do not always rise and sometimes prices can fall quickly. Moreover, most people do not have time to watch their stocks all day long. A stop limit order is an order you place with your broker that will automatically sell your stock if the price falls below a level you predetermine.

Stop Limit Order

A limit order is a type of order you place with your broker that will be filled only at the price you set or better. Thus, a stop limit order is a protective sell order that will sell your stock at the limit price if the price trades at that level. Stop limit orders are always placed below the current price.

Regular Stop Orders

A sell stop order does not have to be a limit order. If you place a simple stop order, the order becomes a market order once the stop price is reached. Unlike a limit order, which can only be filled at the limit price or better, a market order fills at whatever price is available at the time. This can be an advantage in fast-moving markets. For example, if you have a limit order and the price is falling quickly, there is a chance your stock will not sell, or only some of your shares will sell. A regular stop order does not guarantee you a specific price, but it does guarantee your stock will sell if the stop price is breached.

Trailing Stop Orders

Some investors want to hold their stock as long as the price is climbing, but want to sell if the price begins to fall. A trailing stop order is a type of sell order that ratchets higher as the stock price rises. For example, if you use a 5 percent trailing stop, the order will stay 5 percent below the stock price as long as the price is rising. If the price falls more than 5 percent, the order triggers and your stock sells automatically. Trailing stop orders can be limit or regular.

Stop Loss Psychology

When you place a stop limit order, you are committing yourself to selling your stock if the price falls to your stop price. Unfortunately, it can be much easier to set the order than it is to use it. When prices fall, many people rationalize that the price will soon recover and so they will cancel their stop orders. This can be dangerous as stock prices can continue to fall much lower than most people anticipate. Exercising discipline is an important aspect to investing success.

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