Stop-loss and stop-limit orders are ways to manage risk in trading. Traders use it to execute their orders when an reaches a certain price. A stop-loss order becomes a market order at that specific price. Meanwhile, a stop-limit order becomes a limit order at that price. Unlike a regular market order that fills at any price, a stop-order and a stop-limit order both fill only at a specific price or better.
But what are the pros and cons and what situation do you use them in? This article explains it all.
What is a stop-loss order?
A stop-loss order is a type of order that traders use to limit their loss or lock in a profit on an existing position. Stop-loss can sell an asset or stock when it reaches a certain price.
It helps limit your loss on a security position.
For example, if you set a stop-loss order for 5% below the price at which you bought the stock, the stock will limit your loss to 5%. Before using this feature, you may understand the pros and cons of using it.
Pros of using a stop-loss order
- It can limit your potential losses
- It can save you time and effort from monitoring your holdings daily
- Helps prevent emotional influences from affecting your trading decisions
- You can use it to lock in your profits on an existing position
Cons of using a stop-loss order
- No guarantee of the exact price that you want to sell at as they become market orders when triggered. This may result in selling at a low price
- Temporary or short-term price fluctuations can trigger a stop-loss order. This can create an unnecessary sale
- Stop-loss may not suit your trading goals or strategy, especially if you are a long-term investor or a value investor
What is a stop-limit order?
A stop limit, on the other hand, is an order to buy or sell at a specific price once the security or stock price reaches a certain stop price. Once the stock price reaches the stop price, the stop-limit order becomes a limit order to buy or sell at the limit price or better.
A stop-limit order may not get executed if the market price moves away from the limit price. This is different from a stop-loss order that will always execute the setup at the available price.
Pros of using a stop-limit order
- Provides more control over the execution price
- You can use it to avoid buying or selling at unfavorable prices, by avoiding unwanted executions in volatile or illiquid markets
- You can use it to enter or exit positions at specific prices
Cons of using a stop-limit order
- It doesn’t guarantee that it will execute your order, as the market price may move away from your limit price
- Because it doesn’t guarantee execution, this may result in missed opportunities
- It can be more complex to set up and track compared with other setup types
Suggested reading: Market Order vs. Limit Order: Which to Use and Why?
Stop limit vs. stop loss examples
Here are some examples of stop-limit and stop-loss orders in crypto trading:
Stop-Limit Order Example
For example, you want to buy a Bitcoin when it reaches $60,000. Your analysis found if the bitcoin reaches the price, the future gain will be more significant. But, you don’t want to buy when it reaches $60,500 because this will make your profit getting smaller. Monitoring the price fluctuation can make you spend more time. To automate this trade, you set up a stop price of $60,000 and a stop limit of $65,000.
This means that if the bitcoin reaches $60,000 the system will automatically create a buy order and ensure that the trade didn’t exceed $65,000. But if the system hasn’t executed your order while the price is surpassing $65,000, the system will not execute your order. This makes you miss the trade opportunity.
Stop-Loss Order Example
In this case, your analysis says that the price of ETH will be declining for some periods. This market condition will make you lose your asset value. Moreover, you also will lose some potential discount prices. Looking at this situation, you want to sell your asset before your loss is too big. To automate this process, you will set up a stop-loss order in your account. Say you want to sell it when the ETH reaches $2,500.
You can then set up a stop-loss price of $2,500. This means the system will sell your asset when the price reaches $2,500. But, there is a catch: when the market price suddenly drops to $2,400 before reaching $2,500, the system may still execute your order. This will create a larger loss for your trade.
Are stop-limit orders and stop-loss orders good to use for beginner investors?
Both stop-limit and stop-loss orders are useful depending on
- your trading goals,
- and risk tolerance.
These orders are useful if you want to have more control over price when buying or selling stocks and/or assets. These orders are also very useful if you want to protect your profits or limit losses in case of volatile market movements. It can also save you time in daily monitoring your holdings, and prevent emotional influences on trading decisions.
Stop loss orders are risk mitigation tools. Hence, there is no risk and it is safe to use for beginners. But, it requires some knowledge. So you should spend some time researching the various terms of investing and trading beforehand.
In conclusion, both stop loss and stop limit orders can be useful tools for managing risk in trading. It’s important to understand the differences between them and how you can use them in different situations. You should also always review your orders and adjust them according to the market conditions and your trading objectives.
Now that you know the difference between stop limit orders and stop loss orders, it’s time to find out which one fits your trading strategy the best.
Some traders like to use both at the same time because it can help them take a profit and stop losses more accurately.
The main difference to take away is stop loss orders limit potential losses while stop limit orders help to lock in profits during volatile market conditions.
In the end, it all depends on your requirements when trading. So connect your Walbi wallet with the link below and try out a few different trading techniques today.