When trading in the financial markets, it is extremely important to follow the rules of risk management. One of the main rules is limiting losses. Brokers offer several tools that allow you to prevent critically large losses, and one of them is stops orders – stop-loss orders (Stop Loss) and stop limit (Stop Limit). IAFT analysts have prepared a guide for you, in which you will learn what it is, what is the key difference between these orders, and when to use them.
There are essentially two types of stop orders people use on exchanges. In a comparison of Stop Market vs. Stop Limit, you can find a few notable exceptions. For new or casual traders, the two of these won’t really make much sense, because you don’t operate with them on a regular basis.
They are, however, important. Even knowing the difference between the two is a step in the right direction. And if you want to be truly effective on the exchange, you’ll want to know how to operate these two order types. There are several more, but that’s the story for another time.
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What are Stop Market Orders?
Stop market is a category of orders that rely on specified price levels. Depending on the sort of a stop market, the position will be opened or closed upon reaching a designated price level. It’s done automatically so that traders could stick to the plan even when absent from the exchange.
These orders can purchase (buy stop orders) or sell (sell stop orders) cryptocurrencies and other securities upon reaching a price level. What’s more, you can combine several of these order types to remain more in control of your assets and execute your strategy with precision.
The most common type of a stop market order is a stop-loss order. It’s also among the easiest to use and comprehend, as it’s literally there to stop your asset from falling in price further than you can afford. Upon reaching a low price point of your choice, the position will be closed.
When you place a stop market order, you specify the price, but you rarely specify anything else. It’s completely fine for most people, seeing how they use the stop-loss order almost exclusively out of all these order types. In fact, stop-loss is often one of the main features of the interface.
What are Stop-Limit Orders?
Stop-limit orders are similar to stop-market orders in that it’s also a big category of orders, which offer you a great deal of flexibility. These offers also allow you to specify price levels, at which the asset is to be either sold or bought. Unlike stop market orders, these also let you limit the purchase/sale by quantity.
Stop-limit allows you to be more nuanced with your market positions, but it’s essentially a double-edged sword. To use them efficiently, you need a larger degree of market understanding and an ability to predict the price movement more or less accurately. If you don’t, you may find yourself buying too few assets or too many assets when the market is about to enter a very favorable or a very unfavorable condition respectively.
Which is Better?
You’ll generally need to pick one type order of these two because the former is a direct upgrade to the latter. It is possible to use different order categories in different scenarios (for instance, when you want to sell your crypto gradually but otherwise don’t care for the limit).
In reality, however, stop limits are more advanced than stop markets, and the choice depends on how well you understand trading and how well you can use the information given to you. In short, stop markets are better used by casual traders and beginner traders, while stop limits can be useful for more advanced trading.
Features of Stop Loss and Stop Limit
Stop Loss and Stop Limit orders are different orders and it can be difficult for a beginner to understand them. Let’s highlight the features of each of these orders briefly and compare them with each other.
Stop-loss
- Execution at the current market price
- Designed to close the deal
- Protects against excessive losses by automatically buying or selling if the price goes the wrong way
- Effective for any transactions, regardless of market volatility
- It does not affect the amount of profit in any way, it only protects against losses
- In case of slippage, it can be executed at a worse price, which can lead to losses greater than planned
- Can be used for both Instant Execution and Pending Orders
- Does not have an expiration date, and can be executed at any time
Stop-limit
- Execution at a price preselected by the trader
- Designed to create a limit order for the subsequent opening of a transaction
- Protects against excessive losses by placing a limit order only when certain market conditions occur
- Effective in volatile markets where the price can make big jumps in different directions
- Allows you to open a deal to buy or sell at a better price for the trader, which means earning more profit
- With slippage, such orders do not work, the transaction will not open.
- By itself, it is a Limit, so using it for Instant Execution is a priori impossible
- You can set an expiration date to prevent later execution of the order under different market conditions
The Bottom Line
In the end, both stop-limit and stop-loss orders can be useful trading tools for experienced day traders and for those investors who like to tinker around in short-term investments. While stop-limit orders guarantee price, though, stop-loss orders guarantee execution. If you’re looking for a specific number that you want to get out at, say if the stock’s price is plummeting after hours on high volume, then the latter might be your safest bet.
Conversely, if you’re looking to limit your losses because your investment wasn’t performing as well as you would have liked during the given time period, then the former might be easier to use.
