Limit Order vs Stop Order Explained

  • October 13, 2020

Limit order vs. stop order, which one should you choose? You probably know by now, there are many different types of orders you can use for day trading that range from stop orders to limit orders.

Today, I’m going to walk you through a few of them so you can limit your losses and lock in your profits. 

Choosing a Limit Order vs Stop Order

  • Are you're deciding to choose a limit order vs stop order? It's all about finding out what trade entry would work best for you. Are you learning how to buy options and futures? How can learning about the different order help with your trading? I'm glad you asked! We're going to dive into it further in this post. 
Limit Order vs Stop Order

1. Market Orders

“Buy me at any price! Now!”

“Sell me at any price! Now!”

Let's understand market orders to help us further with limit order vs stop order. If you’re placing a market order, you are telling your broker to immediately buy or sell the stock for you at any price.

Yes, at any price. The price might be to your benefit, and it very well might not be though. I hope this raises a red flag for you because if you place a market order, you have no control over the fill price.

A limit order, on the other hand, gives you control back. You get to specify the maximum or minimum price you’re willing to accept. 

The main reason why I don’t like market orders is that you get filled on the bad side of the bid-ask spread. Essentially, a market order buys at the ask (high side) and sells at the bid (low side).

As you know, the market can rapidly reverse, and so then does the bid-ask spread. What ends up happening is you get your order filled at a terrible price.

For example, if the bid-ask spread is $11.95-$11.97, market orders should buy immediately at $11.97 for you, right? Wrong.

By the time your market order arrived at the Exchange, the stock had soared on news to $12.10-$12.15. Unfortunately for you, your buy market order gets filled at $12.15 - a 15 cents slippage. And that is bad, really, bad. 

To put this in perspective, placing a market order is like writing a blank check - dangerous. Typically, market orders do get filled close to the bid or the price, but when they don’t, you’ll be in for a nasty surprise. 

2. Stop Orders

Now lets break down the stop order in limit order vs stop order. Also called a “stop-loss order,” stop orders are used to buy or sell once the price moves past a certain point. At this point, the stop order becomes a market order and is executed.

Stop orders are of two types: buy stop orders and sell stop orders. We typically see traders using stop-loss orders when they are unable to monitor their trades closely. Maybe they are going away on vacation or work a 9-5 and can’t check their charts. 

A buy stop order executes at a stop price that is above the current market price. In contrast, a sell stop order executes at a stop price below the current market price.

Let’s consider a trader who bought FB for $155, and it is now trading at $185. To protect a portion of their gains $15), the trader places a sell order to stop at  $170. If for whatever reason the stock plunges in price (i.e. bad news), the order to sell triggers at $170.

Keep in mind the order might not be filled at $170 since it is now a market order. Furthermore, the price the trade executes may be worse or better than the stop price.

Another point worthy of mention is a stop-loss order increases your risk of exiting a position early. You could find yourself in a situation where a stock plunges in price, only to rise back up.

In the scenario above, what if FB tanked then soared to $200. Unfortunately, you’d be stopped out at $160 and would miss out on any additional gains. 

3. Limit Orders

“Buy me at this price only! Not higher!”

“Sell me at this price only! Not lower!”

A limit order, unlike a market order, limits the price you are willing to pay for the stock. It's an instruction you give to your broker to buy or sell a specific stock at or better than a set price specified by you.

You are in control of your trades, and this is what you ultimately want. But, there is a chance your limit order won't fill if the price moves too quickly after you send your instructions. 

For example, I want to buy 100 shares of TVIX at $34.75, and another 100 shares at $34.74, so I place a limit order to buy at these two prices. Because it is a limit order, there is no guarantee that I will get filled at those prices. If the price rises, my order won't fill until the price falls back down. 

Use limit orders whenever possible when you're deciding between a limit order vs stop order.

How Does a Stop Order Differ From a Limit Order?

  • What's the difference between limit order vs stop order? A limit order lets you set the price you're willing to pay. This sets a stop loss along with your order. Therefore, if price hits a certain level moving down, your order will close. These orders will be really helpful if you're swing trading penny stocks.

1. Marketable Limit Orders

“Buy me now, but up to this price! Not higher!”

“Sell me now, but down to this price! Not lower!”

In my opinion, the most important type of order for day traders is a marketable limit order. The beauty of a marketable limit order is that you set the range you're willing to buy or sell at.

Once sent, a marketable limit order will immediately give you as many shares as possible within the price range you set. I use marketable limit orders when day trading and I generally buy at "ask +5 cents" and I sell at "bid-5 cents".

Let's use TVIX to illustrate. In this scenario, the ask price is $34.77, and you ask your broker to buy 100 shares at "ask price + 5 cents". You should get filled if there's a lot of shares offered at the ask.

But, if the ask price moves up quickly before you get filled, you have already authorized your broker to buy TVIX at a higher price of $34.82 (ask of $34.77 + 5 cents). What this means is your broker will try to buy 100 shares of TVIX for you at the cost of no more than $34.82.

A similar example is also true if you want to short sell on the bid. Once again, you specify the range you're willing to sell at: "the bid - 5 cents". In other words, you are not willing to sell at a price lower than the bid minus 5 cents. 

2. Limit Order vs Stop Order Key Takeaways

  • A limit order tells your broker to fill your buy or sell order at a specific price or better.
  • A stop order activates a market order when the stop price is met.
  • There is no risk of fills or partial fills with stop orders. But, because it is a market order, you may have your order filled at a price much worse than what you were expecting.
  • Use limit orders whenever possible

Conclusion

Learning how to day trade for a living doesn't have to be complicated. That also includes implementing a limit order vs stop order.  In some cases, it may seem overwhelming especially with all the different types of indicators and order types.

And that’s where Bullish Bears can help you. We will help you to untangle the web of information and point you in the right direction. Please come join us on our day trading journey, we won’t disappoint. 

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