Do you know your Stop Loss Order from your Stop Limit Order?

Filling out a stock order correctly is an important skill to have for any investor, including a Passive investor as ETFs trade on the market. This post will help you understand the choices you have when placing a trade, and when to use each type of order, if at all.

The below list shows the available choices from Fidelity, and is fairly indicative of most trading platforms:

• Market Order
• Limit Order
• Stop Loss
• Stop Limit
• Trailing Stop Loss %
• Trailing Stop Loss $
• Trailing Stop Limit %
• Trailing Stop Limit$

Market Order

Executing a Buy or Sell at Market means you will take whatever the current rate is.  Market orders will execute the fastest, as there is no conditional statement involved, however that does not protect them from sharp variations in execution price.  If you issue a market order on Ford stock (F) to sell at $10 it might not execute until some point far below that number, if there is a bear run (a lot of sellers) occurring.  Likewise it is possible you can decide to issue a market Buy when the stock is trading at $10 and it may execute higher. You take what you can get from such a trade.

Market Orders are particularly dangerous to hold overnight, as there is a long period of time where either a stock specific event (earnings disappointment, SEC inquiry etc) or a Macro Economic event that could push down all stocks could occur, you could decide to buy Ford the next day, but an oil crisis may break out overnight.

Limit Order

A Limit Order is the opposite.  With this order you will only ever buy or sell at a fixed point of value.  A good use of a limit order is to buy a stock at or below a certain price, for example, if Ford is trading at $10 you might set a limit to buy at $9.50.  Limit orders offer a degree of safety, but also come with risks. Let’s say you own Ford at $10 and want to sell it at $12, it is possible that the stock could go as high as $12 and not execute, depending on how many other orders are in front of you.  Should the price then decline you will still hold the stock.  A market order in this situation would sell at the next available lower price, perhaps $11.99 if volume is high.

Stop Loss Order

A Stop Loss is a mechanism that is typically used to protect against a downward turn of price.  You would set these on a position you hold already.  For example, Ford at $10 is owned. You can set a Stop Loss order to sell some, or all of your position should the price drop below $9.75.  A Stop Loss order is a Market Order that becomes active when the ‘Stop’ ($9.75 in this case) is hit.  Stop Loss orders can protect against downswings, but might not behave as expected as they are Market Orders once activated, therefore if Ford was to drop to $5 overnight, your Stop Loss order at $9.75 would trigger at Market, so you would sell at $5.

Stop Limit Order

The Stop Limit order differs from Stop Loss in that when the ‘Stop’ price triggers it it becomes a Limit order. To build one of these you will need to set two prices, the Stop Price, and the Limit Price.  Using the Ford example, Stock price $10, Stop price $9.75, Limit Price 9.50.  This would mean that if the price dipped below $9.75 it would attempt to sell the stock, only if the sale price was above $9.50.  If it dropped straight to $5 then you would not sell the position.

Trailing Stop Loss Order %

This tracks the stock price up and down.  You set a % downside that you will accept, and it will trigger a Market Order if the price drifts below that number.  For example, a 5% Trailing Stop Loss Order, if Ford dipped from $10 to $9.50 straight down, it would trigger a Market Sale.  However, if it dipped to $9.60, then went up to $9.70, the % trailing would reset, and the Market Order would trigger now when the price dropped from $9.70 to $9.125 (5% of $9.70 being 48.5 cents).  With this in mind the Trailing Stop Loss can move up and down with the fluctuations of the market, but kick in when a sharp downward movement occurs.  Just like the Stop Loss, if movement occurs overnight, and the price dropped to $5, you would have a market sale at $5.

Trailing Stop Loss Order $

This is similar to the % but you now pick a fixed cash amount on the downside that you could accept before triggering the Market Order.  As it is a fixed amount, the more the stock appreciates, the smaller the movement required to trigger the order.

Trailing Stop Limit Order %

Similar to the Trailing Stop Loss the Trailing Stop Limit Order % triggers a Limit order at the last price that was registered. A 5% Trailing Stop Limit Order on Ford at $10 would mean if it dropped to $9.50 it would become a Limit Order, that would sell at no less than $9.50.  Therefore, should there be a sharp drop to $5 and you miss the trade, you would hold the stock all the way down.

Trailing Stop Limit Order $

This is the same concept as the relationship between the Trailing Stop Loss Order $ and Order %.

IMPORTANT! You can miss limits.

It is important to remember that limit orders can miss you, not only would this happen over night with price movement, but simply if there are too many sellers ahead of you in the transaction -if the price moves away from your limit price, you won’t execute.

Conclusion

It is generally considered safer to use a Limit Order than a Market Order as you are able to control the execution price, however, due to the nature of the market is it important to realize that Limit orders may not execute, meaning that your purchase price, or your protective sale, may not occur.