Definition: A stop limit order combines the “automatic” nature of a stop loss order and a limit order. A stop loss order is placed with your broker, when the price hits your stop, it becomes a limit order. When you set a stop limit order to sell. The market price must come up to, or above your specified price, to be executed. When you set a stop limit order to buy, the market price must come down to, or below your specified price, to be executed. The concept is the same as same using a limit order. To gain a better understanding we will explain the “automatic” nature in an example.
Example: Using A Stop Limit Order – To Sell
Let’s say that after analyzing a chart of Apple’s stock you decide to buy at $420. You also see that if the price drops down to $390, you want to sell immediately to prevent further losses. You don’t have time to watch the stock every second, so you put in a stop limit order to sell at $390. The automatic nature of a stop order allows you to walk away, shower, sleep, a be out with normal society. Anytime the stock drops down to $390, a limit order to sell at $390 is made. Since it is a limit order, the price of the stock must be at or above $390 to be executed. Conceptually, this makes sense. However, THIS CAN BE DANGEROUS. Read on, young Padawan.
Disadvantages of Using A Stop Limit Order – To Sell
Gap Down- When the market moves down during a price level break the stock may gap past your limit order price. Liquidity dries up on the buy side and the price action may skip to a steeply lower price instantly. This typically happens at the open of the market or a surprise news. Your order will not get executed. So, using the same example above with Apple stock, if the price gaps down to $380, your stop limit order will not get filled. Remember that a limit order to sell at $390, means the market price must be at or above $390 to get filled.
The Dangerous Part: When a market gaps down, it usually signifies a change in trend. Meaning, with each consecutive trading day, or period, the price will be trending lower. In worst case situations the stock could be crashing. Because your limit order did not get filled, you are still holding a stock that is going lower. If you aren’t around to manage the trade losses may accumulate dramatically.
Consider The Situation – As a trader you must make observation. What’s the trading volume like? Many buyers and sellers? Or is it one sided? Also market volatility affects the fill time of your order. Thinly traded stocks might affect order execution. There are just a few factors, but when you trade, observe the execution in relation to market conditions. This will help you in future trading scenarios.
Breakout Theory Advice on Using Stop Limit Orders
Typically a stop loss order is a market order by default. Using a stop market order is best when using Breakout Theory’s Trading system. Because of gapping an volatile moments in a stocks price action, to prevent slippage and loss of capital during a trade, we consider position sizing, as well risk management methods that place stops efficiently. Typically a combination of technical analysis methods, and indicators are use to make the process automatic and efficient. When using stop limit orders, it’s best to monitor the trade manually for best execution. In fast moving markets, constant adjustment of a sell limit order price may be needed.