Stop Limit Order is an order (buy/sell) to close a position that only executes when the current market price of an option/stock hit or passes through a predetermined price (i.e.
Stop Price).
Once the Stop Price is passed, the Stop Order becomes a
Limit Order, and can only be executed at a specific price (i.e.
Limit Price) or better.
As you may have noticed, Stop Limit Order is almost similar to
Stop Order. The main difference is that in Stop Limit Order, when the Stop Price is passed, the order will be converted into a Limit Order, whereas for Stop Order, it’ll convert into a Market Order.
Depending on the position on the market you have (long or short), there are 2 types of Stop Limit Order:
a) Sell Stop LimitThis is the stop limit order when you have a
long position on a security.
In this case, the
Stop Price is placed
below current
market price of the security, and the
Limit Price should be placed at least the
same as or
lower than the
Stop Price.
b) Buy Stop LimitThis is the stop limit order when you have a
short position on a security.
In this case, the
Stop Price is placed
above current
market price of the security, and the
Limit Price should be placed at least the
same as or
higher than the
Stop Price.
Characteristic & Risk of Stop Limit Order:Stop Limit Order will remain
inactive until the Stop Price is passed. Once the Stop Price is passed, the order will be activated as a
Limit Order to buy/sell at the specified Limit Price or better.
Therefore, the
advantage of Stop Limit Order is that it provides control over the price at which the order will get filled (i.e. at the Limit Price or better).
However, the
disadvantage is that a Stop Limit Order may never get filled if the market price is worse than the Limit Price. As a result, the position can continue falling with no more protection for the position. This makes a Stop Limit Order a very insecure stop loss method, particularly for the extremely volatile stocks that often experience a gap up or gap down in prices.
Due to this risk, using Stop Limit Order to protect a position is not advisable.
Example:Suppose a Sell Stop Limit order were placed to protect a long position on an option with a Stop Price at $2/contract and Limit Price at $1.5. The current market price is $2.5/contract.
This order would remain inactive, unless the price reaches or drops below $2. When that happens, the order would then turn into a Limit Order.
As long as the order can be filled at $1.5 or higher, the order will be filled.
However, in case the market price gap down at $1 and then continue to fall, the order will not be filled.
The Difference between Stop Limit Order and LIT Order:
Stop Limit Order is actually quite similar to
Limit-If-Touched (LIT) order.
The difference between Stop Limit Order and LIT order is basically on the placement of predetermined price that triggers its execution (i.e. “Stop Price” for Stop Limit Order and “Trigger Price” for LIT Order) and Limit Price relative to the current market price.
* For
Sell order, the
Stop Price & Limit Price for a Sell Stop Limit Order are placed
below the current market price, whereas the
Trigger Price & Limit Price for a Sell LIT Order are placed
above the current market price.
* For
Buy order, the
Stop Price & Limit Price for a Buy Stop Limit Order are placed
above the current market price, whereas the
Trigger Price & Limit Price for a Buy LIT Order are placed
below the current market price.
For the list of other types of order, go to:
Types of Orders in Trading.
Related Topics:
*
Free Trading Educational Video: Learn Technical Tips from Dan Gramza*
Options Trading Basic – Part 1*
Options Trading Basic – Part 2*
Understanding Implied Volatility (IV)*
Option Greek*
Understanding Option’s Time Value*
Learning Candlestick Charts*
Learning Charts Patterns*
Getting Started Trading
