This is a question I get asked all the time: What is the difference between a limit order vs a stop order? If you’ve been wondering about these two order types, I think you’ll find this article very interesting!
In this article, we will answer the following questions:
- What is a limit order?
- What is a stop order?
- How do you know which order to use?
What are we waiting for! Let’s get to it!
What is the difference between a limit order and a stop order?
A limit order is a direct instruction to your brokerage to buy or sell an asset at a specified price or better. The limit order you place will be visible by other traders in the market.
A stop order is a direct instruction to your brokerage to execute a market order when the specific stop price has been met. The stop order is not visible by anyone else.
The differences between the two are subtle, but knowing which order to use and when to use it is important. If you use the wrong order type, there’s a good chance you will lose money in the trade.
When To Use A Limit Order
A limit order is generally used when you want to BUY a stock or option at a specific price or better. Let’s look at an example of what this means.
Say you want to buy Apple (AAPL) stock but you don’t want to pay more than $200 per share.
In this scenario, the limit price would be set at $200. Your brokerage will execute the order for you if the price of the AAPL stock falls below $200.
This is what is meant by buying the stock at a specific price or better.
When To Use A Stop Order
In contrast, you would use a stop order if you want to buy a stock once it goes ABOVE a certain price. Note that you can use a stop order for selling as well but I’ll go over that a bit later on in this article.
Using the same example as above, let’s say you want to buy Apple (AAPL) when it moves higher than $250.
Here you would specify to buy AAPL with a stop order of $250. Your brokerage would execute this order if the price of AAPL moves above $250.
What Is The Difference Between A Limit Order vs A Stop Order?
So let’s recap by using the same example with AAPL stock.
If you want to buy AAPL when it moves above $200, you would be directing your brokerage to BUY AAPL at a $200 STOP.
If the current price of AAPL is at $190, your order will not be executed. In fact, it will sit there in your brokerage account until AAPL moves above $200.
It could take days or even weeks for this to happen. Once AAPL does hit $200, the STOP Order becomes a Market Order.
Now, if you have instructed your brokerage to buy AAPL with a limit order of $200, then you are directing it to buy AAPL stock when it is at $200 or below.
If AAPL opens the session at $190, then your order will automatically be filled since it is below $200.
Using Limit and Stop Orders When SELLING a Stock
When you want to use a Stop or Limit order when selling a stock, everything is flipped.
Here’s what I mean by that:
If you want to SELL AAPL at $200 or better, then you would be making an order to SELL AAPL at $200 LIMIT.
This means that you won’t sell the stock until the price is higher than $200.
If you direct your brokerage to SELL AAPL at a $200 STOP, then your order will be executed when AAPL moves below $200.
Are you confused yet? I know I was when I first tried to wrap my head around these two order types. Luckily for you, I’ve developed a shortcut to understanding them better.
How To Use A Limit Order vs Stop Order
Here’s how I personally trade while using a Stop or Limit order:
For my entry order, I use a STOP ORDER
It makes sense when you zoom out. When a market is rising, I want to buy the stock when it moves above a certain price. But when a market is falling, then I want to make sure I sell the stock when its price falls below a given level.
And that’s why I use a STOP order for my entries.
How to use a stop loss
Sometimes it’s all in the name. A Stop Loss is the same as a Stop Order.
So when I buy a stock and it begins to fall, I want to automatically exit as soon as that stock hits a predetermined price.
If I bought AAPL at $200, then I want to SELL the stock when it drops to $190. The instruction for this is to SELL AAPL at $190 STOP.
For my profit target, I use a LIMIT ORDER
When it comes to buying a stock, I want to be able to sell it as soon as it hits my predetermined price. My rule of trading is: I want to make twice as much money as I risk in the market.
Here’s what I mean by that:
If I bought AAPL stock at $200, and I wanted to risk $10 per share, my stop loss would be at $190.
Since I risked $10, I want to make back $20 per share, therefore, my profit target would be $220.
For this trade, I want to make more than $220 so therefore, I would SELL AAPL at higher LIMIT Order.
Is this helpful? I really hope it is!
What is a MARKET ORDER?
A Market Order is a standard trade that uses the current market price of the asset. This means that you did not use either a Stop or Limit order.
Market Orders can be buy or sell orders, and your brokerage will execute the trade at the price that the asset is currently trading.
I have always viewed Market Orders as handing your brokerage a blank check.
I don’t like writing blank checks if you are wondering how I feel about making a Market Order.
When would you ever use a market order?
To be honest, in my mind a Market Order is like the ‘Oh Sh*t Order.’
What do I mean by that? I’ll show you another example to explain:
Let’s say that you wanted to buy 100 shares of AAPL, but for some reason, you accidentally entered and bought 1,000 shares of AAPL instead.
If that isn’t an ‘Oh Sh*t moment,’ I don’t know what is!
The moment you realize that you made a mistake, hit the Sell button and use a Market Order to sell at its current price.
Here’s another example of a time to use a Market Order.
So let’s say you wanted to BUY AAPL stock when it moves higher than $250 per share. Now imagine you were supposed to enter it as a Limit Order but accidentally entered it as a Stop Order.
At this point, hit the Sell button! Use a Market Order and sell at whatever price you can to salvage your money. Trust me on this: it usually only gets worse.
What about buy orders? Let’s say you want to buy AAPL stock when it moves ABOVE $200, but you used the wrong type of order and bought it below that price. As soon as you realize your mistake, hit the Market Order sell and get out of that trade!
Here’s something I always try to live by when trading:
When you’ve made a mistake, liquidate!
Write it down and remember it because it is a good rule to have. Trust me when I say you will need it at some point!
So now you know that I think of the market order as the “oops” order.
Aside from when you make a mistake, I personally never use Market Orders because like I said, it’s like writing your brokerage a blank check.
If you advise your brokerage to buy shares of AAPL and you don’t specify a price or an order type, then the brokerage will buy the stock at whatever price is currently available.
Remember that when trading I like to have a controlled entry and exit price into the market. This puts me in control of the trade so I know exactly what price I am getting and getting out at.
As you know, I am German and as a German, I like to be precise. 😉
When I’m trading, I like the market to come to me because I don’t like to chase the market.
That’s why when I enter a position, I am using a STOP order because it allows me to control my entry price and limits my risk for a loss.
I use a LIMIT order when I take profits on a trade. I do this by telling my brokerage to automatically sell my position once it hits my ideal profit target.
By using LIMIT orders and STOP orders in this way, I can automate my trading and don’t have to sit in front of the computer all day long. My order instructions will take care of this and automate it for me.
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