One bad trade can wipe out weeks of gains. That’s why traders rely on tools that help manage risk automatically, even when they’re not watching the market.
Two of the most common are stop-loss and stop-limit orders. Both trigger a sale when an asset hits a certain price, but they work in slightly different ways.
A stop-loss sells immediately once the trigger price is reached.
A stop-limit sets a floor and will not sell unless that minimum price is met.
Understanding stop-loss vs stop-limit orders can help you avoid unexpected losses and missed opportunities.
Pro Tip: During volatile markets, it’s crucial to monitor your portfolio’s performance. By utilizing Ziggma’s portfolio tracker feature, you can keep up to date on the fundamentals for each company you own, your dividend income, and more.
What are Stop-Loss Orders?
A stop-loss order is used to sell shares once the price falls below a point you’ve set. It’s a way to manage downside risk by automatically triggering a sale when the stock begins to dip. When that price is hit, the order becomes a “market order” (an order to buy or sell a security immediately). Meaning that your shares will sell at the next available price, whatever that may be.
Stop-losses work remarkably well in stable markets, but when prices move quickly, you may not get the price you hoped for. This is because the order guarantees an exit, not a return. If the stock drops during the sale, your actual loss could end up larger than you planned.
For example, let’s say you purchase a stock at $100 and set a stop-loss at $90 to cap your potential loss. If the stock falls to $90, your order activates, and the system sells your shares at the current market price. But that specific market price might not be $90 by the time the order executes. This can happen if there’s heavy selling pressure, bringing the price per share down to $89 or lower.
So while your stop-loss is $90, it’s not unreasonable to assume it might sell for $89.
Can Short Sellers Use Stop-Loss Orders?
Short sellers can also use stop-loss orders.
If a trader wants to cap their losses on a shorted stock, they might place a stop-loss at $60.
When the stock price reaches $60, the order triggers a market buy and closes your position at the next available price.
What are Stop-Limit Orders?
While stop-loss orders are effective for quickly exiting the market, they do not always allow you to do so on your terms.
A stop-limit order provides more control by adding a second condition: the lowest price you are willing to accept.
Unlike stop-loss orders, which become market orders as soon as they are triggered, a stop-limit order becomes a “limit order” (an order to buy or sell a security at a specified limit price or better).
Let’s use the $100 share example again. You place a stop at $90. A stop-limit order allows you to add another number that serves as your minimum sell price. In this case, you might want to set the limit to $88.
If the stock falls to $90, your order will activate and sell, but only if it can secure a trade price of $88 or more. If the price drops too quickly and the stock falls below that level (for example, it hits $87), your order will not be filled. You will keep the shares, for better or worse.
Can Short Sellers Use Stop-Limit Orders?
Just like stop-loss orders, stop-limit orders can help short sellers curb risk when closing a position. In this case, you would set a stop price, say $60, and a limit price just above it, like $61. If the stock price reaches $60, the order activates, but it will only allow the shares to be bought back if it can do so at $61 or lower. That way, you avoid buying at a higher price if the stock continues to rise.
Benefits and Risks of Using Stop-Loss and Stop-Limit Orders
Stop-loss vs stop-limit orders can protect you in various ways, but each carries its own set of downsides. We’ll look at their biggest advantages and disadvantages next so you can decide which approach best fits your trading goals.
Benefits
The biggest benefit of a stop-loss order is speed. When your stop price triggers, you quickly exit a falling position.
The biggest benefit of a stop-limit order is control over price. You can set the worst price you’re willing to accept, which helps you avoid selling too low when the market may be volatile.
Benefits of both include:
- They are both designed to limit potential losses.
- It’s an automatic process where you can set it and forget it.
- They’re both useful for long positions (selling to avoid losses) and short positions (buying to cap losses).
- You can easily define price boundaries, especially with stop-limit orders.
Risks
The biggest risk of a stop-loss order is price slippage. Your sell order could be for far less than your specified stop price in a fast-moving market.
The biggest risk of a stop-limit order is missing the trade entirely if the market skips over your limit price.
Risks of both include:
- There is no guarantee that you’ll get the price you wanted or that the order will go through.
- In volatile markets, either order can fail to protect you the way you expected.
- Poorly placed stop prices can result in getting shaken out of positions you want to hold.
Stop-Loss vs Stop-Limit: Which Should You Use When?
Guarantees in the stock market are unusual, but that’s the idea behind these orders.
A stop-loss order guarantees that your order will go through, but it doesn’t promise what price you’ll get. A stop-limit order guarantees a price, but not the trade.
So, when should you use one over the other? It depends on what kind of risk you’re trying to manage. If you’re holding a highly liquid stock and want to limit your downside in a sharp drop, such as a negative earnings report coming out overnight, a stop-loss allows you to exit quickly the next morning, even if you give up a few cents on the price.
But let’s say you’re trading a thinly traded small-cap stock. A stop-loss could sell you out far below your trigger price if there’s not enough demand when your order hits. In this situation, a stop-limit might make more sense for you. You’ll only sell if buyers are willing to pay your minimum, which protects you from giving up your position too cheaply.
You might even want to use both on the same stock.
Reach your investing goals
Join more than 30,000 people tracking their investment portfolios with Ziggma.
Bottom Line
Choosing between a stop-loss vs stop-limit order comes down to whether you care more about guaranteeing the trade or controlling the price. Understanding the difference helps you protect your position, avoid surprises, and trade with a clear plan.
Frequently Asked Questions
What’s the Difference Between a Market Order, Limit Order, and Stop Order?
A market order is executed instantly at the current market price. In contrast, a limit order only activates when the market price reaches a specified limit and won’t execute until that price is reached. A stop order comes into effect when the stop-loss price is reached, but the trade could execute at a price lower than this stop-loss point.
Which is Better Stop-Loss or Stop-Limit?
Stop loss orders allow you to protect against additional losses and are beneficial in volatile markets. Once the stop price hits, the order turns into a market order. Stop-limits help prevent an order from executing outside a predefined price range. Once the stop price has hit, the order will only be filled at a price equal to or better than the limit price. Each has its benefits and is suitable for different needs.
Why You Should Always Use a Stop-Loss
A stop-loss order is important when trying to manage risk. Using a stop-loss will allow you to exit a position when a price drops to a specific level.
What is the 7% Stop-Loss Rule?
The 7% stop-loss rule is a risk management strategy that allows traders to automatically sell a security if its price falls 7% below the purchase price. This method is designed to avert substantial losses by promoting discipline and eliminating emotional decisions.