TRADING WITH STOPS & LIMITS
Stop and limit orders work in different ways:
Stop order:
- A stop order is generally used to stop a loss.
- The order is triggered when the market trades at or through the stop level specified.
- The broker will then exercise the order on a best effort basis at the next price.
- In a fast moving or illiquid market there may be some ‘slippage’ i.e. the actual price obtained may be different to the trigger level.
Limit order:
- A limit order is generally used to limit a profit
- The order is triggered when the market trades at or through the limit level specified.
- The broker will then exercise on a best effort basis on the next best price (you will never be filled at a worse price)
Orders to open:
Sell orders:
- If a sell order is placed above the current market, this will be entered as a limit order.
- If a sell order is placed below the current market, this will be entered as a stop order.
Buy orders:
- If a buy order is placed above the current market, this will be entered as a stop order
- If a buy order is placed below the current market , this will be entered as a limit order
Summary – Orders to open:
| Above Current Price | Below Current Price | |
|---|---|---|
| Sell order | Limit Order | Stop Order |
| Buy order | Stop Order | Limit Order |
Order to close
- These are attached to specific existing open positions.
- The system will thus not allow the client to enter into a stop or limit on the wrong side of the market.
WARNING: ‘Orders to open’ placed when the underlying market is closed can be extremely risky, as these orders may be entered as stop orders.
This is best explained by way of example.
- Assume stock ABC closed the previous day at 50
- A ‘buy order to open’ is placed at 52 before the market opens
- The ‘buy order’ level (52) is above the current price (50), so the order is treated as a stop order.
- f the market opens at 55 the order is immediately triggered and filled on a best effort basis by the broker. This will be at the next price after the trigger level, which may be at 56.
- So even though the order level was at 52 the order is filled at 56. This is market convention but perhaps not what the client is after.
This scenario can be avoided by rather waiting for the market to open before placing ‘orders to open’ or by calling orders into the dealing room.
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