We have already discussed the idea of conditional orders in financial markets and of course in the forex market. The stop limit order is one such order and among the most common conditional orders.
A conditional order is an order that carries a condition with it for its proper and final execution. Here of course we are going to focus on the stop limit order and see what it can do for forex traders and also go through an example of one such order.
So in this article we want to focus on the stop limit order. As the name suggests, this order has the characteristics of both a limit order and of course a stop order. Put together, they can be a great instrument for risk management. Without further ado, here is the stop limit order.
The Basic Definition of Stop Limit Order
As was mentioned in the intro, a stop limit order is among the most prevalent and highly applied conditional orders. Such orders are quite useful for forex traders and all traders in financial markets, in that they provide a higher degree of control and management over their directives to the broker, and by proxy the market at large.
But there is another important aspect of the stop limit order that ought to be mentioned here. Other than the fact that it is a conditional order, the stop limit order is also a combinatory order. Meaning that it has been formed through the combination of two other orders. One being the stop loss order and the other being the limit order.
Let’s have a quick glance at each of them:
- Stop loss order: in this type of order, when the directive is issued by the trader to the broker, there is a threshold defined to constraint losses. When a certain price or threshold is reached, then the order is executed in order to prevent further losses, or ensure that enough profits have been earned through the trade.
- Limit order: a limit order, on the other hand, is a directive issued by a trader informing the broker to execute the buy or sell trade at the specific price requested by the trader or a better price.
So put these two together and you have the stop limit order. Not only do they give traders a way to ensure losses are mitigated by putting a stop order on their directive. It also gives them the upper hand of being able to define the terms of their trade on their own.
However, precisely because such conditions are placed upon the order, the chances of its being filled will be lower than expected. This is the case with many orders, where the trader is not sure whether the order will be filled by the broker or not, depending among various factors.
But you need to use this order carefully, because you have to be able to define the terms of the order very precisely so that you can ensure profits are obtained and losses are prevented.
Now that we know the fundamentals of the stop limit order, let us take a close look at the features of this order.
Characteristics of the Stop Limit Order
In order to find the exact characteristics of the stop limit order, we need only take a look at the two orders that are used to create this order – namely the stop order and the limit order.
We already discussed both of them in the previous section.
But how exactly do they translate into the features of the stop limit order?
The best way to see this is to first consider the stop limit order as the stop order. As was mentioned, the stop order is merely known for its risk management ability. It does not ensure great prices, but merely the fact that it can help you not sustain too much losses.
But when you combine that with a limit order as well, then you get something really special. Not only do you have the characteristic of really great risk management due to the stop order part of the deal, but you also get the features of the limit order as well.
This means not only you get a way to prevent further losses, but you also have a chance to put in a directive for a definite price that you have set or even a better price.
But, to reiterate, the added complexity of these two orders makes it that much more improbable for the order to be filled by the broker.
Therefore, you should always use caution and consideration when you are picking the order to send to the broker.
How Does the Stop Limit Order Work?
So far, if you have been paying attention, then you must have picked up on the main theme of our discussion with regard to the stop limit order – i.e. the twofold nature of this order.
The twofold nature of this order means your work as a trader is also doubled. So when you want to place this order, you need to specify two price points for the broker. The first one is with regard to the stop order and the second one with regard to the limit order.
So you first clarify for the broker the stop order price. This is the price or threshold you define that works as the trigger button for the execution of your trade.
Then you need to clarify further the limit order price. This is of course the price at which you want your trade to be filled or at a better price.
But as you will see, the chances of your getting a better price than your requested limit order price are slim to none. Only under really favorable conditions do such things occur.
So, in actuality, the limit price is the best price you will get for selling your position or the best price you are willing to pay for buying.
Example of the Stop Limit Order
To provide an example for the stop limit order, let us suppose that you want to sell your Tesla shares.
For the sake of this example, let us further suppose that Tesla shares are being traded at $270 at this moment.
To sell your shares, you place a stop limit order with your broker.
As was mentioned, the stop limit order is twofold:
- Stop order part: for the stop order you specify the price to be $275 which is the price that triggers or activates the order. So, when the price of Tesla hits this amount, your order is triggered.
- Limit order part: and for the limit order side of things, you specify the price to be $280. This means the best price you are asking for is $280.
Therefore, as long as the price remains between $275 and $280 your order is filled.
The stop limit order is considered among the more advanced orders in financial markets. That clearly includes the foreign exchange market. The reason it is complex is that it is made of two other orders. So when traders want to place this order they have even more factors to specify for the broker.
But on the plus side, the stop limit order provides a higher degree of control, management, and possible profits for the trader.