Trading Risk Management: Stop Loss vs Stop Limit

For both investors and swing traders, it’s vital the difference between stop loss vs stop limit orders is understood. Both order types form a critical part of our trading risk management. At its core, swing trading is the risk of a unit of money in return for a multiple of that unit.

TIM THOMAS

A stop-loss, or stop order, is an instruction to a broker, placed on entry to a trade. The order will be to buy or sell a position at a particular price. Orders will fill at the best available price, which may be some distance above or below our target depending upon market conditions.

TIM THOMAS

Stop Loss Orders

Placing a stop-limit order, by contrast, means that a limit order triggers when the price hits our target. For example, a trader has identified previous demand for a stock at $50 and concludes below this price level, the price will fall to $40. The trader places a sell stop limit order at $49 where the limit order to sell is also $49. This limit order is created automatically only if the stop price of $49 is met.

TIM THOMAS

Stop Limit Order

TIM THOMAS

What are the Advantages and Disadvantages of Stop Loss Orders?

The principal advantage of using stop-loss orders is that they compel us to determine our maximum loss and exit position before we even enter a trade. “Set and forget” swing traders, or day traders who need to be away from their screens for periods during the day, also get some reassurance that their positions will be protected against sudden, dramatic price moves in their absence.

TIM THOMAS

The problem is that stop-loss orders become market orders once the target price is hit - meaning that they will execute (fill) at the best price then available. And whether or not we get out of the trade at our desired price will depend on there being enough traders prepared to buy or sell at that price.

TIM THOMAS

TIM THOMAS

What are the Advantages and Disadvantages of Stop Limit Orders?

TIM THOMAS

In contrast, the advantage of stop-limit orders is that they guarantee that we need only exit a trade at our specified price or better. And this certainty is a great help in managing risk.

TIM THOMAS

The problem is that in rapidly moving markets it may not be possible for orders to be filled immediately at the specified price. In these circumstances, our positions will remain open until price comes back to the limit price or we cancel the order.

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