In the stock market, there are several different types of orders which give you some flexibility in how your trades are executed. Many of these types of trades can be set to “trigger” based on stock prices and conditions. When you place either a stop or limit order, it tells the broker (or the computer if you are trading online) that you do not want the market price (the current price) that the stock is trading for. You are telling the broker/computer that you want the stock to move in a specific direction before it is bought or sold. This protects you against buying at a bad price. In this article, you will learn the differences between a stop and a limit order. I will attempt to explain why each is used and how you can use these tools to your advantage.
Stop and limit orders are very similar. With a stop order, the trade will only be executed when the stock you are buying or selling has reached the designated stop price, which you set. When (or if) the stock reaches this price, the broker/computer executes your order. For example, if you own a stock which is currently trading at fifty dollars ($50), and you put in a stop order to sell out at forty dollars ($40); your order to sell will only be executed when the stock drops to forty dollars or less. If it never drops to this price, your order will not execute. This protects you from buying the stock at a higher price than you are willing to pay.
Stop orders have the advantage to allowing a person to set a price they are willing to pay, and not have to stay glued to their computer watching prices. You don’t have to actively monitor the market, as the buy or sell order is automated based on the price you set. Some brokerage firms may not charge for this service, others will charge a few dollars more than a regular “market order”.
The downside to a stop order is that there is no guarantee that the order is going to be filled at the price you want to buy it at. The price may go the other direction and your order would never be filled. In contrast, once a market order is executed, the stock will be bought or sold at the current price.
A limit order sets both the maximum and minimum amount of money that you are willing to either buy or sell a stock for. If you want to buy a stock at thirty dollars, and it is selling for forty, you can set the price limit at thirty. If the stock drops to thirty or below your broker (or the computer) will buy the amount of stock you told him to purchase in your name. On the other hand, a limit to sell guarantees the stock will not be sold for less than the price you put the limit on, but it could be sold for more.
Stock trading can be an intimidating activity. The rules and language are often quite complicated and hard to understand for a beginner. Be sure to educate yourself as much as you can on the details and workings of the market before investing any of your money.