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Investors have long relied on trading instructions, also known as orders. A basic trade instruction establishes what you want to happen in your portfolio. The most basic order is a market order, which buys or sells an asset immediately, regardless of the price.

Other order types are triggered when an asset hits a certain price. Limit orders trigger a purchase or a sale if selected assets hit a certain price or better. Meanwhile, stop orders trigger a purchase or sale if selected assets hit a certain price or worse. The two main types of stop orders are stop-loss and stop-limit orders.

Stop-Loss Orders

A stop-loss order is typically used to sell stocks. Under this instruction, your portfolio (either through its manager or an automated system) will sell the selected stock as soon as it dips below a certain price.

For example, say you own Stock A. It currently sells for $12 but has been losing value lately. You set a stop-loss order for $10. If Stock A hits $10, your portfolio will immediately try to sell your Stock A shares.

This is known as “converting to a market order.” That means that your stop-loss order (“look for this price and sell”) will become a market order (“sell the asset immediately”). The distinction is important because a stop-loss order cannot guarantee you a specific price. Your portfolio will immediately market the asset, but your actual return will depend on how the price moves during the transaction.

For example, say that Stock A hits $10. Your stop-loss order converts to a market order, triggering a sale. In the time it takes for you to sell your shares of Stock A the price goes down by another $0.15. This means that you will actually sell the shares for $9.85.

Or, in the alternative, say that Stock A hits $10 momentarily before rebounding to $11.50. The stop-loss order does not consider changing circumstances, so it will not unwind based on recovered value. The market order will sell your shares for $11.50, which is at least less of a loss.

A stop-loss order can also be used to buy stocks. Short-sellers, for example, would set a stop-loss order to buy if the price of a stock they have shorted ever goes above a certain price. For example, you could set a stop-loss order for Stock B at $15. This means that if that stock ever climbs to $15, your portfolio will execute a market order to buy Stock B.

Stop-Limit Orders

The stop-limit order exists to smooth out some of the unpredictability of a stop-loss order.

As noted, the biggest problem with stop-loss is that it converts to a market order upon execution. This means that your portfolio will execute the trade at a potentially unpredictable price. Our sale of Stock A will trigger at $10 per share, but we have no control over the price that stock will actually sell for.

A stop-limit order attempts to solve this. When the asset hits the stop price, triggering the order, this instruction becomes a “limit” order rather than a market order.

A limit order is an instruction for your portfolio to buy or sell an asset at a specific price or better. This means that it will only sell an asset at or above the set price, and it will only buy the asset at or below the set price.

Under a stop-limit order, you can specify that you would like to sell if it falls below a certain price, but you don’t want to sell it for any less than another price.

For example, say we set a stop-limit order for Stock A. Our stop price would be $10, while our limit price would be $8. If the price of Stock A hits $10 or below, the order would convert to a limit order set at $8. This would mean that our portfolio will immediately sell Stock A for any price at or above $8. If the price of the stock falls too fast and the portfolio can’t sell it for the limit price, it will not sell.

As with stop-loss orders, investors can use stop-limit orders to purchase securities if they have taken a short position. In this case you would issue an order to buy an asset if it goes above a stop price, but no higher than the established limit price.

Stop-Loss vs. Stop-Limit Orders

A stop-limit order is used to guard against a particularly volatile market. It allows you to sell your asset, but only within certain boundaries.

Returning to our example, if Stock A hit its $10 stop price but then immediately kept falling to $4 per share, you might consider that too much of a loss. At that price you might prefer, instead, to hang on to Stock A in hopes that it will regain its value.

A stop-limit order gives you that flexibility. It will sell the stock, but only within a range that you define. A stop-loss order would execute the sale at $4, losing more money than you had intended.

On the other hand a stop-loss order can guarantee your transaction. The same protections that limit your losses in a stop-limit order can also prevent your portfolio from selling the asset at all.

Suppose that Stock A opens at $7 per share, below both your $10 stop price and your $8 limit. Your stop-limit order will convert into a limit order, but it will not execute the sale. Your portfolio will wait for Stock A to go back up to $8 before selling.

A limit order can become a liability. If after a day of trading Stock A settles at $5 per share over a day of trading and never recovers, your order will never go through. You will have lost the chance to sell for $7 per share. In trying to mitigate your losses you will have actually magnified them.

The Bottom Line

There are different varieties of stock orders. Some orders execute immediately; some execute only at a specific time or price; and others have additional conditions attached. A stop-loss order guarantees a transaction but not a price; a stop-limit order guarantees a price but not a transaction. What kind of order you use can make a big difference in the price you pay and the returns you earn, so it’s important to be familiar with the different types of stock orders.

Tips

  • Consider talking to a financial advisor about whether your returns could be aided by stop-loss or stop-limit orders. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
  • Before you start buying stock, it’s important to understand the vocabulary of the investing world. Perhaps no lingo is more important than that which surrounds the different types of stock orders. Depending on whether you want to make a transaction immediately or wait until certain conditions have been met, you’ll need to place a different kind of order through your brokerage.

Photo credit: ©iStock.com/TolikoffPhotography, ©iStock.com/monsitj, ©iStock.com/RichVintage

Eric Reed Eric Reed is a freelance journalist who specializes in economics, policy and global issues, with substantial coverage of finance and personal finance. He has contributed to outlets including The Street, CNBC, Glassdoor and Consumer Reports. Eric’s work focuses on the human impact of abstract issues, emphasizing analytical journalism that helps readers more fully understand their world and their money. He has reported from more than a dozen countries, with datelines that include Sao Paolo, Brazil; Phnom Penh, Cambodia; and Athens, Greece. A former attorney, before becoming a journalist Eric worked in securities litigation and white collar criminal defense with a pro bono specialty in human trafficking issues. He graduated from the University of Michigan Law School and can be found any given Saturday in the fall cheering on his Wolverines.
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