Stop Loss vs Stop Limit
A sell stop is entered at a price below the current market price. Investors usually use it to limit a loss or protect a profit on a stock they own. Know the differenceThere are two types of sell stops, stop orders and stop limit orders.
With the Dow Jones industrial average moving hundreds of points a day – and sometimes per hour – should you use stop orders that automatically sell your stock if it hits a certain price?Some experts say yes, if you know what you are doing. Others say they could do more harm than good, especially in fast-moving markets.
Although investors get more interested in stop orders when the market is gyrating wildly as it has since August, they work best in normal or slow-moving markets.A stop order, also called a stop-loss order, is an order you place with your brokerage firm to buy or sell a certain number of shares once a stock hits a certain price, known as the stop or trigger price.
Since I’m only talking about downside protection here, I’ll only talk about sell stop orders. A sell stop is entered at a price below the current market price. Investors usually use it to limit a loss or protect a profit on a stock they own. Know the differenceThere are two types of sell stops – stop orders and stop limit orders.
Many investors have been burned because they didn’t understand the difference.The thing to remember is that a stop guarantees execution (but not price) while a stop limit order guarantees price (but not execution). “Neither can do both and that is the problem,” says Randy Frederick, director of trading and derivatives with the Schwab Center for Financial Research.
Here is the difference :
Stop order : This is an order to sell stock at the best price available once the stock hits the stop price. Suppose Apple is trading at $400 and you place a stop order at $375. If Apple drops to $375, your order becomes a market order and your stock will be sold at the best possible price. In a tame market, you will usually get a price very close to $375, but in a market that is rapidly spiraling downward, the price could be a lot lower. Another danger : Suppose Apple closes at $380. After the market closes it announces horrible earnings.
The next morning it opens at $350. If your stop order still stands, your stock will be sold at or around $350 – far below your stop price. Stop limit order. This is an order to sell at or above a certain price (called the limit price) after the stop price has been reached. The limit price can be above, below or equal to the stop price.
Suppose Apple is trading at $400. “You could enter a stop limit order where the stop price is $375 and the limit price is $370 or better,” says Frederick.In a quiet market, if Apple falls to $375 you might get out close to $375 in a sale. But if it’s quickly gapping downward, the price could blow right through $375 and $370, and your stock won’t be sold unless it turns around and comes back up to $370 again.
“With a stop limit you are not guaranteed an exit even while the market is open,” says Nicole Sherrod, managing director for TD Ameritrade’s trader group.Or, as in the previous example, if Apple closes at $380 and after reporting bad news opens the next day at $350, your stock won’t be sold.”The stop limit is for the person who says, ‘If the stock starts to lose, I want to get out, but if it moves very quickly where I would take a large loss, I just want to hang on it,” Frederick says.
The mechanicsYou can place a stop order on stocks and exchange traded funds – but not for traditional mutual funds. You can place it when you buy stock or at any time thereafter. You can place it on all or some of your shares in a company. Most brokerage firms do not charge to place stop orders but do charge their regular commission if the order is executed.
You can specify how long you want the order to stay in place : Day orders are good for that day only (excluding after-hours trading). Contrary to what their name implies, good-till-canceled orders expire after a certain number of days that varies by firm. At Schwab, they expire after 60 days, but you can ask to be notified when they expire.
Some brokerage firms use slightly different terminology so make sure you understand exactly what you are doing. Stop orders can be useful if you are not tracking the market all day on your computer or mobile device, but they cannot guarantee a wise investment move.