Limit Order vs. Stop Order

When trading stocks it is not always possible (or desirable) to monitor the prices of stocks you hold or are considering holding all the time. In these cases most brokerages will allow you to place conditional instructions with them to make certain trades when a price is reached, these are referred to as Limit Orders and Stop Orders. Understanding the difference between the two is important if you want to ensure that what you want to happen does happen when placing a Limit Order vs. a Stop Order.

Limit Order

A limit order can be used to both buy a share you are interested in or to sell shares you currently have based on certain pricing parameters you establish.
A limit order is used to instruct your broker to trade a certain number of shares at a price that you specify or better. In a buy situation this would mean that you are instructing your broker to buy at the limit price or lower. For a selling situation this means that you are instructing your broker to sell at the limit price or higher.

With limit orders you are essentially setting prices where you want to take advantage of a good price to either buy shares or sell shares. Once you enter a limit order as soon as the price you've specified has been met it will become a market order with the brokerage and they will carry out the transaction. When placing a limit order you often need to specify an expiry date for your order and if the price target you've established hasn't been hit before then the order will be removed.

Stop Order

A stop order, also often referred to as a stop-loss order, is a similar mechanism where you place an order to either buy or sell shares based on a set price. The difference from a limit order is that in both situations a stop order refers to a situation where you want to limit the loss you will incur in a certain transaction.

In a selling situation, where you already hold the share, a stop order is instructing the broker to sell the share at the stop price or lower. In this way you care minimizing your loss on the sale of the share, as opposed to a limit order where you are setting a higher price where you want to lock in your profit. In a buying situation a stop order is used when you are certain you want to buy a share but you haven't bought yet and want to limit any loss you face in buying should the price go up. As such when you enter a buy order your broker will buy the share at the stop price or higher.

Similar to a limit order once you have entered your stop order with your broker and the target price has been met a market order will be placed. Also with a limit order you typically enter an expiry date on your order after which it will be deleted from the system.

Limit Order vs. Stop Order

When entering a limit order or a stop order it is very important that you understand the distinction, because a buy order at your set price or higher vs. your set price or lower will trigger very different market orders. Confusing the two can quickly result in your making an order that is completely the opposite of what you were intending to do.

Limit orders and stop orders are common features with most online brokerages and while stop orders are typically free limit orders can come with a fee attached so it is important to review the specific details your broker offers. Once you are comfortable using stop orders and limit orders they can be very useful tools to make orders on terms you're comfortable with even when you're not there to physically make the order yourself.
By Jeffrey Glen

Copyrighted 2016. Content published with author's permission.

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