In this article, we will answer the following questions:
What is a limit order?
What is a stop order?
When do you use what order?
What is the difference between a limit order and a stop order?
A limit order instructs your broker to buy or sell at a specific price or better. A stop order will only be executed once the market price moves beyond the specified price, a.k.a. “stop price.”
Knowing which order to use is extremely important because when you try to enter or exit a trade and you are using the wrong order, you will lose money.
When To Use A Limit Order
You would use a limit order if you want to BUY a stock at a specific price or better.
Example: Let’s say you want to buy Apple (AAPL), and you don’t want to pay more than $250 for the stock.
In this case, you specify BUY AAPL at $250 LIMIT.
Your broker will only execute this order for you if the price for AAPL is below $250. This means that you would buy the stock for a price of $250 or better.
When To Use A Stop Order
You would use a limit order if you want to BUY a stock once it goes ABOVE a certain price.
Example: Let’s say you want to buy Apple (AAPL) when it moves higher than $250.
In this case, you specify BUY AAPL at $250 STOP.
Your broker will only execute this order is AAPL moves above $250. This means that you would buy the stock for a price of $250 or above.
What Is The Difference Between A Limit Order And A Stop Order?
Let’s use the example from above:
Let’s say you want to buy AAPL when it moves above $250. So you’re instructing your broker to BUY AAPL at $250 STOP.
If AAPL opens at $240 the next morning, your order will not be executed. It will be sitting in the market until AAPL moves above $250. As soon as it does, your stop order will become a MARKET ORDER and you will get filled at the next available price, which could be at $250 or above.
If you would have instructed your broker to BUY AAPL at $250 LIMIT, then you’re telling your broker to buy AAPL as long as the price is at $250 or below.
So if AAPL opens at $240 the next morning, your order is immediately being executed, since the current price is below the $250 that you specified.
Your order will get filled at $240 because it is better than $250.
Is this making sense?
Using Limit and Stop Orders When SELLING a Stock
If you plan to SELL a stock, everything is “flipped.”
Here’s an example:
If you want to SELL Apple at $250 or better, then you would instruct your broker to SELL APPL at $250 LIMIT.
But since you are selling, “better” means a higher price than $250.
In this case, your order gets executed as soon as the price of AAPL moves above $250 because now you are selling at “$250 or better.”
If you instruct your broker to SELL AAPL at $250 STOP, then your order will be executed as soon as AAPL moves below $250.
As you can see, things can easily get confusing, so let me give you a shortcut:
How To Use Limit Orders vs. Stop Orders
Here’s how I personally trade:
For my entry order, I use a Stop Order
In a rising market, I want to BUY as soon as a stock moves above a certain level. Because I want to make sure that the uptrend continues.
In a falling market, I want to SELL as soon as a stock moves below a certain level.
And that’s why I use a STOP order for my entries.
For my stop loss, I use a Stop Order
The name already says it: Stop Loss = Stop Order.
Here’s why: When I bought a stock, and the stock is going down, I want to automatically exit as soon as the stock hits the predefined level.
As an example, if I bought AAPL at $250, I want to SELL the stock when it moves down to $240.
That’s why I would instruct my broker to SELL APPL at $240 STOP.
For my profit target, I use a Limit Order
When I bought a stock, I want to sell it as soon as it hits my predefined level. And as a rule of thumb, I like to make twice as much money as I risk.
Let’s say I BOUGHT AAPL at $250.
Let’s say I want to risk $10 per share, i.e. my stop loss would be at $240.
If I risk $10, I want to make $20 per share, so my profit target would be at $270.
If I want to SELL AAPL as soon as prices move above $270, I would instruct my broker to SELL APPL at $270 LIMIT.
Is this helpful?
What is a Market Order?
If you don’t specify that you are using a STOP order or a LIMIT order, then your broker assumes that you want to buy (or sell) at the market price.
This is called a MARKET order.
When using a market order, you instruct your broker to BUY (or sell) a stock at whatever price it is currently trading.
It’s like writing a blank check.
And I don’t like writing blank checks.
When would you ever use a market order?
Well, for me personally, a market order is the so-called “oh sh*t order.”
Here’s what I mean:
Let’s say you wanted to buy 100 shares of Apple, but accidentally, you bought 1,000 shares of Apple (that would be an “oh sh*t” moment.)
The moment you realize that you make a mistake, SELL. Use a MARKET order and sell at whatever price, because trust me: it usually only gets worse.
Another example: Let’s say you wanted to BUY Apple as soon as it moves ABOVE $250, but you used the wrong order and bought it while it’s still below $250. The minute you realize you made a mistake, use a MARKET order and get out!
Here’s something to remember:
When you’ve made a mistake, liquidate!
Write this down. It’s good one. You will need it.
Now you know when to use a market order: It’s the “oops” order.
Other than this, I would personally never use it because it’s like writing a blank check to your broker.
If you tell your broker to buy Apple, and you don’t specify a price and an order type, it means buy Apple at whatever price is right now available.
And I like to have a controlled entry and exit in the market so that I know exactly at what price I’m getting in and out. After all, as you know, I am German… and as a German, I like it to be precise.
Summary: Limit Order vs. Stop Order
I like the market to come to me. I don’t like to chase the market.
That’s why I use a STOP order to enter into a position.
And I’m using a STOP order for my stop loss so that I can limit my risk.
I’m using a LIMIT order for taking profits so that my broker automatically sells my position once I hit my profit target.
Using limit orders and stop orders this way, I can automate my trading and don’t have to sit in front of the computer all day long.
Trading Futures, options on futures and retail off-exchange foreign currency transactions involves substantial risk of loss and is not suitable for all investors. You should carefully consider whether trading is suitable for you in light of your circumstances, knowledge, and financial resources. You may lose all or more of your initial investment. The lower the day trade margin, the higher the leverage and riskier the trade. Leverage can work for you as well as against you; it magnifies gains as well as losses. Past performance is not necessarily indicative of future results.