Setting a loss limit along with a profit goal is a good idea. For example, many futures traders have a rule to risk two ticks in pursuit of three ticks. That means that they’ll sell a position as soon as it loses two ticks in value and as soon as it gains three ticks in value.
Even traders who do not have a rule like that often set a limit on how much they’ll lose per trade. Other traders use computer programs to guide their buys and their sells, so they sell their positions automatically. Brokers make setting limits easy by giving customers the choice of a stop order or a limit order to protect their positions.
Stop orders
A stop order is an order to buy or sell a security as soon as a security moves beyond the current market price. A stop buy order is set above the current market price, and it is used to manage a short position. A stop sell order is set at a price below where the market is now, and it is used to protect a profit or limit a loss on a security that you already own.
If you want to make sure you sell a block of stock when it falls below $30 per share, for example, you can enter a stop order at $30 (telling your broker “Sell Stop 30”). As soon as the stock hits $30, the broker sells it, even if the price goes to $29 or $31 before all the stock is sold. This is often known as a stop loss order.
A version of a stop, known as a trailing stop, is used to help protect a profit. You can enter a trailing stop order at the current market with a stop loss price below the current market price. It would be set to trail, or automatically increase, as the stock price does.
Limit orders
A limit order is an order to buy or sell a security at a specific price or better: lower than the current price for the buy order, higher than the specific price for a sell order.
If you want to make sure you sell a block of stock when it is at $30 per share, for example, you can enter a limit order at $30 (telling your broker, “Sell Limit 30”). As soon as the stock hits $30, the broker sells it, continuing to place the order as long as the price stays at $30 or higher.
If the price goes even a penny below $30, the limit is no longer enforced, and the broker stops selling your position. After all, no buyers are going to want to pay an above-market price just so you can get your order completed!
Stop limit orders
A stop limit order is a combination of a stop order and a limit order. It tells the broker to buy or sell at a specific price or better but only after the price passes a given stop price.
| Buy Orders | |||
| Stop Order | Limit Order | Stop Limit Order | |
|---|---|---|---|
| Order instructions | Buy Stop 30 | Buy Limit 30 | Buy Stop 30 Limit 31 |
| Market Price ($) | Action after the stock hits $30 | ||
| 28.50 | Nothing | Buy | Buy |
| 29.00 | Nothing | Buy | Buy |
| 29.50 | Nothing | Buy | Buy |
| 30.00 | Buy | Buy | Buy |
| 30.50 | Buy | Nothing | Buy |
| 31.00 | Buy | Nothing | Nothing |
| 31.50 | Buy | Nothing | Nothing |
| Sell Orders | |||
| Stop Order | Limit Order | Stop Limit Order | |
|---|---|---|---|
| Order Instructions | Sell Stop 30 | Sell Limit 30 | Sell Stop 30 Limit 29 |
| Market Price ($) | Action after the stock hits $30 | ||
| 28.50 | Sell | Nothing | Nothing |
| 29.00 | Sell | Nothing | Sell |
| 29.50 | Sell | Nothing | Sell |
| 30.00 | Sell | Sell | Sell |
| 30.50 | Nothing | Sell | Nothing |
| 31.00 | Nothing | Sell | Nothing |
| 31.50 | Nothing | Sell | Nothing |
