If you want to start actively trading rather than HODL, you’ll likely need to use more than market orders. A stop-limit order provides more control and customizability. In fact, it’s one of the most common risk management techniques to limit potential losses. However, the concept can be confusing for beginners.
Still, what is stop limit meaning and how does it differ from other stop and limit orders? In this article, we’ll explain what a stop limit order is, the key differences and pros and cons of using it over other order types.
Stop Limit Meaning
A stop-limit order combines a stop trigger and a limit order. Stop-limit orders allow traders to set the minimum amount of profit they’re happy to take or the maximum they’re willing to spend or lose on a trade. Once you set a stop-limit order and the trigger price is reached, a limit order will be placed automatically, even if you are logged out or offline. You can strategically place stop-limit orders by considering resistance and support levels and the asset’s volatility.
In a stop-limit order, the stop price is the trigger price for the exchange to place a limit order. The limit price is the price at which your order will be placed. You can customize the limit price, which is usually set higher than the stop price for a buy order and lower for a sell order. This difference accommodates market price changes between the time the stop price triggers and the limit order is placed.
Limit Order vs. Stop Loss Order vs. Stop Limit Order
Limit orders, stop-loss orders, and stop-limit orders are some of the most common order types. Limit orders let you set a range of prices you’re happy to trade at, a stop-loss order sets a stop price that triggers a market order, and a stop-limit order combines aspects of the two. Let’s dive in further:
Limit Order
When you set a limit order, you choose a maximum purchase price or minimum sale price. Your exchange will automatically attempt to fill the limit order when the market price meets or is better than your limit price. These orders are useful when you have a target entry or exit price and don’t mind waiting for the market to meet your conditions.
Typically, traders place sell limit orders above the current market price and buy limit orders below the current market price. If you place a limit order at the current market price, it will likely be executed in a few seconds (unless it’s a low-liquidity market).
For example, if the market price of Bitcoin is $32,000, you could set a buy limit order at $31,000 to purchase BTC as soon as the price hits $31,000 or lower. You might also place a sell limit order at $33,000, meaning that the exchange will sell your BTC if the price goes to $33,000 or higher.
Stop-loss Order
A stop-loss is a conditional instruction that a trader gives to the cryptocurrency exchange. When a cryptocurrency price touches the predefined level, the order automatically converts into a market order, which executes at the next available price. The stop-loss can be set at any price level and can instruct the crypto exchange to buy or sell the cryptocurrency, depending on the nature of the existing position.
Stop-limit Order
As mentioned, a stop-limit order combines a stop trigger and a limit order. The stop order adds a trigger price for the exchange to place your limit order. Let's see how it works.
How Does A Stop Limit Order Work?
The best way to understand a stop-limit order is to break it into parts. The stop price acts as a trigger to place a limit order. When the market reaches the stop price, it automatically creates a limit order with a custom price (limit price).
Although the stop and limit prices can be the same, this isn’t a requirement. In fact, it would be safer for you to set the stop price (trigger price) a bit higher than the limit price for sell orders. For buy orders, you can set the stop price a bit lower than the limit price. This increases the chances of your limit order filling after it triggers.
Examples Of Stop Limit Orders
Buy Stop Limit
Imagine that BNB is currently at $300 (BUSD), and you'd like to buy when it starts to enter a bullish trend. However, you don't want to pay too much for the BNB if it quickly begins to rise, so you need to limit the price you’ll pay.
Suppose that your technical analysis tells you an uptrend might start if the market breaks above $310. You decide to use a buy stop-limit order to open a position, in case the breakout happens. You set your stop price at $310 and your limit price at $315. As soon as BNB reaches $310, a limit order to buy BNB at $315 is placed. Your order might be filled with a price of 315 or lower. Note that $315 is your limit price, so if the market goes up too quickly above it, your order might not be filled completely.
Sell Stop Limit
Imagine that you bought BNB at $285 (BUSD) and it’s now at $300. To prevent losses, you decide to use a stop-limit order to sell BNB if the price drops back to your entry. You set up a sell stop-limit order with a stop price of $289 and a limit price of $285 (the price you purchased BNB at). If the price reaches $289, a limit order to sell BNB at $285 will be placed. Your order might be filled with a price of 285 or higher.
Advantages Of Stop Limit Order
A stop-limit order lets you customize and plan out your trades. We can't always be checking prices, especially in the 24/7 crypto market. Another advantage is that a stop-limit order lets you set a suitable amount of profit to take. Without a limit, your order would be filled at whatever the market price is. Some traders prefer to hold than sell at any cost.
Disadvantages Of Stop Limit Order
Stop-limit orders share the same disadvantages as limit orders, mainly because there’s no guarantee they will execute. A limit order will only start to fill when it reaches a specified price or better. However, that price may never be met. Even though you can create a gap between your limit and stop prices, the gap may not be enough sometimes. Highly volatile assets can overshoot the spread you place in your order.
Liquidity can also be a problem if there aren't enough takers to fill your order. If you're worried about your orders only partially filling, consider using fill or kill. This option specifies that your order should only execute if it can be filled completely. However, note that the more conditions you add to your order, the less likely it will execute at all.
Closing Thoughts
As a recap, a stop-limit order is a powerful tool to minimize losses in case the price goes against you. There is also the added benefit of not needing to be actively trading for the order to complete. By combining multiple stop-limit orders, it’s easy to manage your holdings whETHer the price falls or rises.
As the wise words say, ‘practice makes perfect,’ and trading is no exception. Now that you’ve understood stop limit meaning, you should go try it out on your demo account before diving right into it. Make sure you understand how they work and try incorporating it as one of your risk management techniques.
