Thanks to advancements in trading platforms and financial technology, investors can buy and sell stocks with the click of a mouse or the tap of a finger. But before investors get around to buying stocks, they first need to know the mechanics of stock trading.
When an investor places an order to buy or sell a stock, there are a few various types of orders that can be placed, depending on an individual’s preferences. Two commonly utilized methods of stock orders are stop-loss and stop-limit. While they sound similar and are somewhat related, they have differing effects and are suitable for differing circumstances.
Let’s examine these two popular types of orders.
Stop-Loss vs. Stop-Limit Order
The stop-loss order is one of the most popular ways for traders to limit losses on a position. When an investor buys a stock, it is important to evaluate the potential downside risks. In other words, just as it is useful to know when to buy a stock, an investor should think about how far they are willing to ride a stock down.
Placing stop-loss orders allows for limited downside. Suppose an investor places an order to initiate a position in a stock. By using a stop-loss order, the investor could predetermine how much downside they are willing to absorb. For example, the investor could instruct his or her broker to sell the stock if it falls 10%.
There are certain instances in which a stop-loss order can be a very valuable tool in the investor’s toolbox. If an investor goes on vacation or is otherwise unable to access their brokerage account, a stop-loss order can be useful.
The downside of the stop-loss order is that it becomes a market order once the stop-loss level is triggered. Thus, if the stock blows past the stop-loss level due to a spike in volatility or major news event, the sell order could be executed significantly below the anticipated level.
On the other hand, an investor can place stop-limit orders. A stop-limit order is carried out by a broker at a predetermined price, after the investor’s desired stop price has been taken out. Once that stop price has been reached, the stop-limit order becomes a limit order to sell the stock at the limit price or better.
Of course, the stop-limit order is not guaranteed to be executed. Should the stock price rapidly decline past the stop-limit price and not recover, the order won’t be executed.
The Bottom Line
In this age, investors can trade all day, from their computers or on their mobile devices. Trading has gone mobile, and investors have more control of their investing strategies than ever before.
Stop-loss and stop-limit orders can be valuable strategies that investors may want to consider, depending on the circumstances. They have tangible benefits, including greater control over incurred downside. However, as noted, there are disadvantages to each strategy.
As a result, investors should do more research on their own to determine whether these trading strategies are appropriate.
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